By David Snowball

This fund is now the Carillon Reams Unconstrained Bond Fund.

Objective and Strategy

The fund seeks to maximize total return consistent with the preservation of capital.  The fund can invest in almost any sort of fixed-income instrument, though as a practical matter their international investments are quite limited.  The fund’s maturity will not normally exceed eight years, but they maintain the option of going longer in some markets and even achieving a negative duration (effectively shorting the bond market) in others.  They can use derivative instruments, such as options, futures contracts (including interest rate futures contracts), currency forwards or swap agreements (including credit default swaps) to enhance returns, increase liquidity and/or gain exposure to particular areas of the market.  Because they sell a security when it approaches fair market value, this may be a relatively high turnover fund.

Adviser

Scout Investments, Inc. Scout is a wholly-owned subsidiary of UMB Financial, both are located in Kansas City, Missouri. Scout advises the eleven Scout funds. As of June 30, 2012, assets under the management of the Advisor were approximately $22.37 billion.  Scout’s four fixed-income funds are managed by its Reams Asset Management division, including Low-Duration Bond (SCLDX), Core Bond (SCCYX, four stars) and Core Plus Bond (SCPZX, rated five star/Silver by Morningstar, as of October 2012).

Manager

Mark M. Egan is the lead portfolio manager of the Fixed Income Funds. Thomas M. Fink, Todd C. Thompson and Stephen T. Vincent are co-portfolio managers of the Fixed Income Funds. Mr. Egan joined the Advisor on November 30, 2010. He oversees the entire fixed income division of the Advisor, Reams Asset Management, and retains oversight over all investment decisions. Mr. Egan was a portfolio manager of Reams Asset Management Company, LLC (“Reams”) from April 1994 until November 2010 and was a portfolio manager of Reams Asset Management Company, Inc. from June 1990 until March 1994. Mr. Egan was a portfolio manager of National Investment Services until May 1990.

Management’s Stake in the Fund

Messrs. Egan, Fink and Thompson have each invested over $1,000,000 in the fund.  Mr. Vincent has between $10,000 – 50,000 in it.

Opening date

September 29, 2011.

Minimum investment

$1,000 for regular accounts, reduced to $100 for IRAs or accounts with AIPs.

Expense ratio

0.99%, after waivers, on assets of $45 million (as of October 2012).

Comments

There are 6850 funds of all kinds in Morningstar’s database.  Of those, precisely 117 have a better one-year record than Scout Unconstrained Bond.

There are 1134 fixed-income funds in Morningstar’s database.  Of those, precisely five have a better one-year record.

98.3% of all funds trail Scout Unconstrained between November 1, 2011 and October 30, 2012.  99.6% of all fixed-income funds trailed Scout for the same period.

Surprised?  You might not be if you knew the record of the management team that runs Scout Unconstrained.  Mark Egan and his team from Reams Asset Management have been investing money using this strategy since 1998.  Their audited performance for the private accounts (about $231 million worth of them) is stunningly better than the records of the most renowned bond fund managers.  The funds below represent the work of the three best-known bond managers (Jeff Gundlach at DoubleLine, Bill Gross at PIMCO, Dan Fuss at Loomis) plus the performance of the Gold-rated funds in Morningstar’s two most-flexible categories: multi-sector and world.

Annualized Performance Ending September 30, 2012

You’ll notice that the performance of Scout Unconstrained does not equal the performance of the Unconstrained Composite.  The difference is that the team bought, in the private accounts, deeply distressed securities in the 2008 panic and they’re now harvesting the rewards of those purchases.  Since the fund didn’t exist, its investors don’t have the benefit of that exposure. Clark Holland, a Portfolio Analyst on the Fund, reports that, “We strive to invest the separate accounts and the mutual fund as closely as possible so returns should be similar going forward.”

Just because I’m a cautious person, I also screened all bond funds against the trailing record of the Unconstrained Bond composite, looking for close competitors.  There were none.

But I’m not sure why.  The team’s strategy is deceptively simple.  Find where the best values are, then buy them.  The Reams website posits this process:

STEP 1: Determine whether the bond market is cheap or expensive by comparing the current real interest rate to historical rates.

STEP 2: Focus on sectors offering relative value and select securities offering the highest risk‐adjusted return.

STEP 3: Continually measure and control exposure to security‐ and portfolio‐level risks.

It looks like the fund benefits from the combination of two factors: boldness and caution.

It’s clear that the managers have sufficient confidence in their judgment to act when other hesitate.  Their 2012 Annual Report cites one such instance:

A contribution to performance in the asset-backed securities (ABS) sector can be traced to our second lien or home equity holdings, which strongly outperformed.  We purchased these securities at an extreme discount after the 2008-2009 financial crisis, when defaults on home equity loans were high. Since then, default rates declined, the perceived risk of owning these securities lessened, and the prices of the securities have risen sharply.

As you comb through the fund’s reports, you find discussions of “airline enhanced equipment trust certificates” and the successful exploitation of mispricing in the derivatives market:

High-yield index swaps (CDX) such as those we own, which represent groups of credit default swaps (CDS), usually are priced similarly to high-yield cash bonds. Due to somewhat technical reasons, a price gap opened, in the second quarter of this year, between the price of high-yield CDX index swaps and high-yield cash bonds .We took advantage of the price gap to buy the CDX index swap at an attractive price and captured a nice return when pricing trended back toward a more normal level.

One simple and bold decision was to have zero long exposure to Treasuries; their peers average 35%.   As with RiverPark Short Term High Yield, the fact that their strategy (separate accounts plus the fund) has attracted a relatively small amount of investment, they’re able to drive performance with a series of relatively small, profitable trades that larger funds might need to skip over.

At the same time, you get a sense of intense risk-consciousness.  Cautious about rising interest rates, the managers expect to maintain a shorter average duration as they look for potential investments. In his October 3, 2012 letter to investors, Mr. Egan lays out his sense of how the market is evolving and how his team will respond:

What to do? Recognize the reality of a challenging environment, focus on your realistic goals as an investor, and be ready to seize opportunities as they arise.  A well-known investor recently opined as to the death of equity as an asset class.  Our take is the death of static risk allocations, or even what constitutes risk, along with buy and hold investing.  The successful investor will be aware of the challenges we face as a society, understand the efficacy or lack of it in the various (mostly political) solutions prescribed, and allow volatility, and the inevitable mispricing that will result, to be your guide. Flexibility and nimbleness will be required.  For our part, we have positioned accounts in a cautious, conservative stance as the cost of doing so has rapidly declined. We may be early and we may forgo some modest gains in risk assets, but it is both appropriate and in keeping with the style that has generated returns well in excess of our peers over most time periods.

Bottom Line

You need to approach any “too good to be true” investment with care and diligence.  The track record behind SUBFX, which is splendid and carefully documented, was earned in a different sort of investment vehicle.  As assets grow, the fund’s opportunity set will change and, possibly, narrow.  That said, the managers have successfully invested substantial sums via this strategy for nearly 15 years; the fact that they’ve placed millions of their own dollars at risk represents a very serious endorsement.

Fund website

Scout Unconstrained Bond.  Mr. Egan also wrote a very good white paper entitled “Fixed Income: The Search for Total Returns in Volatile Markets” (March 2012).  If you’re intrigued by the fund, you’ll get a better sense of the managers’ approach.  Even if you’re not, you might well benefit from their discussion of “the growing risks of not taking risks.”

Fact Sheet

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

This fund has been liquidated.

Objective and Strategy

Stewart Capital Mid Cap Fund seeks long-term capital appreciation.  It invests, primarily, in domestic midcap stocks.  While it is technically a “diversified” fund, the managers warn that they prefer to invest in “a relatively small number of intensively researched companies.”  They operationalize “relatively small” as 30-60.  They target firms that don’t need “large amounts of leverage to execute their business plan” and firms with sustainable business advantages (favorable demographics and long-term trends, high barriers to entry, good management teams, and high returns on invested capital).

Adviser

Stewart Capital Advisors, LLC, was founded in August 2005.  It is a wholly-owned subsidiary of S&T Bank, headquartered in Indiana, PA.  As of December 31, 2011, Stewart had $965 million in assets under management.

Managers

Matthew A. Di Filippo, Charles G. Frank, Jonathan V. Pavlik, Malcolm E. Polley, Helena Rados-Derr and Nicholas Westric.  Mr. Di Filippo is the senior manager and the adviser’s investment strategist.  Mr. Polley is president and CIO.  His investing career started on Black Monday, 1987 and includes 25 years of primarily-midcap investing.  Except for Ms. Rados-Derr and Mr. Westric, the managers have all been with the fund since inception.  Each of the managers also handles something like 100-300 private accounts.

Management’s Stake in the Fund

Modest.  Three of the managers have invested between $10,001-50,000 in the fund: Polley, Di Filippo and Pavlik.  The others have invested under $10,000.  I expressed my concern about such modest commitments to President Polley.  He writes:

I could require that staff invest solely in the fund, but realize that a portfolio that is solely mid-cap oriented for some folks does not meet their risk parameters.  Also, I want staff to invest in the fund on its merits. That said, I have exactly two investments: S&T Bank stock and the Stewart Capital Mid Cap Fund.  I also have two children in college and have been using some of my investment in that fund to pay for that expense.  So, I believe I put my money where my mouth is.

Opening date

December 29, 2006. The fund converted to no-load on April 1, 2012.

Minimum investment

$1,000 or $100 for accounts with an automatic investment plan.

Expense ratio

1.50%, after waivers, on assets of $37.0 million.

Comments

I wandered by the Stewart Capital booth at Morningstar Investment Conference in June, picked up the fund’s factsheet and reports, and then stood there for a long time.  Have you ever had one of those “how on earth did I manage to miss this?” moments? As I looked at the fund’s record, that’s precisely what went through my mind: small, no-load, independent fund, great returns, low risk, low minimum investments.  Heck, they’re even in Steeler Country.  How on earth did I manage to miss this?

Part of the answer is that Stewart was not always a no-load fund, so they weren’t traditionally in my coverage universe, and their marketing efforts are very low-key.

There’s a lot to like here. The two reliable fund rating services, Morningstar and Lipper, agree that SCMFX is at the top of the midcap pack in both risk management and returns.  Here’s the Morningstar snapshot:

(Morningstar ratings, as of 10/30/12)

Morningstar’s estimate of tax-adjusted returns places Stewart in the top 1% of mid-cap funds over the past five years.

Lipper supports a similar conclusion:

(Lipper Leaders ratings, as of 10/30/12)

The fund has a striking pattern of performance over time. Normally good funds make their money either on the upside or the downside; that is, they consistently outperform in either rising or falling markets. Stewart seems to do both.  It has outperformed its peer group in eight of eight down quarters in the past five years (2008 – Q3 2012) but in only four of 11 rising quarters. But it still wins in rising markets. In quarters when the market has been rising, SCMFX gains an average of 10.65% versus 10.58% for its peer group, reflecting the fact that its “up” quarters rarely trail the market by much and sometimes lead it by a lot.

When I asked the simple question, “which mid-cap funds have been as successful? And screened for folks who could match or better Stewart over the past one, three and five year periods, I could find only four funds in a universe of 300 midcaps. Of those, only one fund, the $1.6 billion Nicholas Fund (NICSX), was less volatile.

That’s a distinguished record in a notably volatile market: 10 of the past 23 quarters have seen double-digit gains (six) or losses (four) for midcap stocks.

The fund is distinguished by effective active management. They buy the stocks they expect to outperform, regardless of the broader market’s preferences. They target stocks where they anticipate a 15% annual rate of return and which are selling at a discount to fair-value of at least 15%. Their question seems to be, “would we want to own this whole company?”  That leads them to buy businesses where the industry is favorably positioned (they mostly avoid financials, for example, because the industry only thrives when assets are growing and Stewart suspects that growth is going to be limited for years and years) and the individual firm has exceptional management. An analysis of the portfolio shows the result. They own high quality companies, ones which are growing much more quickly (whether measured by long-term earnings, cash flow, or book value) than their peers.  And they are buying those companies at a good price; their high-quality portfolio is selling at a slight discount (in price/earnings, price/sales, price/cash flow) to their peers.

Bottom Line

This is arguably one of the top two midcap funds on the market, based on its ability to perform in volatile rising and falling markets. Their strategy seems disciplined, sensible and repeatable. Management has an entirely-admirable urge “to guard against … making foolish decisions” based on any desire to buy what’s popular at the moment.  They deserve a spot on the due diligence list for anyone looking to add actively-managed, risk-conscious equity exposure.

Fund website

Stewart Capital

Fact Sheet

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

This profile has been updated. Find the new profile here.

Objective

The fund seeks high current income and capital appreciation consistent with the preservation of capital, and is looking for yields that are better than those available via traditional money market and short term bond funds.  They invest primarily in high yield bonds with an effective maturity of less than three years but can also have money in short term debt, preferred stock, convertible bonds, and fixed- or floating-rate bank loans.

Adviser

RiverPark Advisors, LLC. Executives from Baron Asset Management, including president Morty Schaja, formed RiverPark in July 2009.  RiverPark oversees the six RiverPark funds, though other firms manage three of them.  RiverPark Capital Management runs separate accounts and partnerships.  Collectively, they have $567 million in assets under management, as of July 31, 2012.

Manager

David Sherman, founder and owner of Cohanzick Management of Pleasantville (think Reader’s Digest), NY.  Cohanzick manages separate accounts and partnerships.  The firm has more than $320 million in assets under management.  Since 1997, Cohanzick has managed accounts for a variety of clients using substantially the same process that they’ll use with this fund. He currently invests about $100 million in this style, between the fund and his separate accounts.  Before founding Cohanzick, Mr. Sherman worked for Leucadia National Corporation and its subsidiaries.  From 1992 – 1996, he oversaw Leucadia’s insurance companies’ investment portfolios.  All told, he has over 23 years of experience investing in high yield and distressed securities.  He’s assisted by three other investment professionals.

Management’s Stake in the Fund

Mr. Sherman has over $1 million invested in the fund.  At the time of our first profile (September 2011), folks associated with RiverPark or Cohanzick had nearly $10 million in the fund.  In addition, 75% of Cohanzick is owned by its employees.

Opening date

September 30, 2010.

Minimum investment

$1,000.

Expense ratio

1.25% after waivers on $197 million in assets (as of September 2012).  The prospectus reports that the actual cost of operation is 2.65% with RiverPark underwriting everything above 1.25%.  Mr. Schaja, RiverPark’s president, says that the fund is very near the break-even point.

There’s also a 2% redemption fee on shares held under one month.

Comments

The good folks at Cohanzick are looking to construct a profitable alternative to traditional money management funds.  The case for seeking an alternative is compelling.  Money market funds have negative real returns, and will continue to have them for years ahead.  As of June 28 2011, Vanguard Prime Money Market Fund (VMMXX) has an annualized yield of 0.04%.  Fidelity Money Market Fund (SPRXX) yields 0.01%.  TIAA-CREF Money Market (TIRXX) yields 0.00%.  If you had put $1 million in Vanguard a year ago, you’d have made $400 before taxes.  You might be tempted to say “that’s better than nothing,” but it isn’t.  The most recent estimate of year over year inflation (released by the Bureau of Labor Statistics, June 15 2011) is 3.6%, which means that your ultra-safe million dollar account lost $35,600 in purchasing power.  The “rush to safety” has kept the yield on short term T-bills at (or, egads, below) zero.  Unless the U.S. economy strengths enough to embolden the Fed to raise interest rates (likely by a quarter point at a time), those negative returns may last through the next presidential election.

That’s compounded by rising, largely undisclosed risks that those money market funds are taking.  The problem for money market managers is that their expense ratios often exceed the available yield from their portfolios; that is, they’re charging more in fees than they can make for investors – at least when they rely on safe, predictable, boring investments.  In consequence, money market managers are reaching (some say “groping”) for yield by buying unconventional debt.  In 2007 they were buying weird asset-backed derivatives, which turned poisonous very quickly.  In 2011 they’re buying the debt of European banks, banks which are often exposed to the risk of sovereign defaults from nations such as Portugal, Greece, Ireland and Spain.  On whole, European banks outside of those four countries have over $2 trillion of exposure to their debt. James Grant observed in the June 3 2011 edition of Grant’s Interest Rate Observer, that the nation’s five largest money market funds (three Fidelity funds, Vanguard and BlackRock) hold an average of 41% of their assets in European debt securities.

Enter Cohanzick and the RiverPark Short Term High Yield fund.  Cohanzick generally does not buy conventional short term, high yield bonds.  They do something far more interesting.  They buy several different types of orphaned securities; exceedingly short-term (think 30-90 day maturity) securities for which there are few other buyers.

One type of investment is redeemed debt, or called bonds.  A firm or government might have issued a high yielding ten-year bond.  Now, after seven years, they’d like to buy those bonds back in order to escape the high interest payments they’ve had to make.  That’s “calling” the bond, but the issuer must wait 30 days between announcing the call and actually buying back the bonds.  Let’s say you’re a mutual fund manager holding a million dollars worth of a called bond that’s been yielding 5%.  You’ve got a decision to make: hold on to the bond for the next 30 days – during which time it will earn you a whoppin’ $4166 – or try to sell the bond fast so you have the $1 million to redeploy.  The $4166 feels like chump change, so you’d like to sell but to whom?

In general, bond fund managers won’t buy such short-lived remnants and money market managers can’t buy them: these are still nominally “junk” and forbidden to them.  According to RiverPark’s president, Morty Schaja, these are “orphaned credit opportunities with no logical or active buyers.”  The buyers are a handful of hedge funds and this fund.  If Cohanzick’s research convinces them that the entity making the call will be able to survive for another 30 days, they can afford to negotiate purchase of the bond, hold it for a month, redeem it, and buy another.  The effect is that the fund has junk bond like yields (better than 4% currently) with negligible share price volatility.

Redeemed debt (which represents 33% of the June 2011 portfolio) is one of five sorts of investments typical of the fund.  The others include

• Corporate event driven (18% of the portfolio) purchases, the vast majority of which mature in under 60 days. This might be where an already-public corporate event will trigger an imminent call, but hasn’t yet.  If, for example, one company is purchased by another, the acquired company’s bonds will all be called at the moment of the merger.
• Strategic recapitalization (10% of the portfolio), which describes a situation in which there’s the announced intention to call, but the firm has not yet undertaken the legal formalities.  By way of example, Virgin Media has repeatedly announced its intention to call certain bonds in August 2011.  Buying before call means that the fund has to post the original maturities (7 years) despite knowing the bond will cash out in (say) 90 days.  This means that the portfolio will show some intermediate duration bonds.
• Cushion bonds (14%), a type of callable bond that sells at a premium because the issued coupon payments are above market interest rates.
• Short term maturities (25%), fixed and floating rate debt that the manager believes are “money good.”

What are the arguments in favor of RPHYX?

• It’s currently yielding 100-400 times more than a money market.  While the disparity won’t always be that great, the manager believes that these sorts of assets might typically generate returns of 3.5 – 4.5% per year, which is exceedingly good.
• It features low share price volatility.  The NAV is $10.01 (as of 6/29/11).  It’s never been high than $10.03 or lower than $9.97.  Their five separately managed accounts have almost never shown a monthly decline in value.  The key risk in high-yield investing is the ability of the issuer to make payments for, say, the next decade.  Do you really want to bet on Eastman Kodak’s ability to survive to 2021?  With these securities, Mr. Sherman just needs to be sure that they’ll survive to next month.  If he’s not sure, he doesn’t bite.  And the odds are in his favor.  In the case of redeemed debt, for instance, there’s been only one bankruptcy among such firms since 1985 and even then the bondholders are secured creditors in the bankruptcy proceedings.
• It offers protection against rising interest rates.  Because most of the fund’s securities mature within 30-60 days, a rise in the Fed funds rate will have a negligible effect on the value of the portfolio.
• It offers experienced, shareholder-friendly management.  The Cohanzick folks are deeply invested in the fund.  They run $100 million in this style currently and estimate that they could run up to $1 billion. Because they’re one of the few large purchasers, they’re “a logical first call for sellers.  We … know how to negotiate purchase terms.”  They’ve committed to closing both their separate accounts and the fund to new investors before they reach their capacity limit.

Bottom Line

This strikes me as a fascinating fund.  It is, in the mutual fund world, utterly unique.  It has competitive advantages (including “first mover” status) that later entrants won’t easily match.  And it makes sense.  That’s a rare and wonderful combination.  Conservative investors – folks saving up for a house or girding for upcoming tuition payments – need to put this on their short list of best cash management options.

Financial disclosure

Several of us own shares in RPHYX, though the Observer has no financial stake in the fund or relationship with RiverPark.  My investment in the fund, made after I read an awful lot and interviewed the manager, might well color my assessment.  Caveat emptor.

Fund website

RiverPark Short Term High Yield

Fact Sheet

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

Objective

The fund seeks a combination of growth and income. Northern’s Investment Policy Committee develops tactical asset allocation recommendations based on economic factors such as GDP and inflation; fixed-income market factors such as sovereign yields, credit spreads and currency trends; and stock market factors such as domestic and foreign earnings growth and valuations.  The managers execute that allocation by investing in other Northern funds and outside ETFs.  As of 6/30/2011, the fund holds 10 Northern funds and 3 ETFs.

Adviser

Northern Trust Investments.  Northern’s parent was founded in 1889 and provides investment management, asset and fund administration, fiduciary and banking solutions for corporations, institutions and affluent individuals worldwide.  As of June 30, 2011, Northern Trust Corporation had $97 billion in banking assets, $4.4 trillion in assets under custody and $680 billion in assets under management.  The Northern funds account for about $37 billion in assets.  When these folks say, “affluent individuals,” they really mean it.  Access to Northern Institutional Funds is limited to retirement plans with at least $30 million in assets, corporations and similar institutions, and “personal financial services clients having at least $500 million in total assets at Northern Trust.”  Yikes.  There are 51 Northern funds, seven sub-advised by multiple institutional managers.

Managers

Peter Flood and Daniel Phillips.  Mr. Flood has been managing the fund since April, 2008.  He is the head of Northern’s Fixed Income Risk Management and Fixed Income Strategy teams and has been with Northern since 1979.  Mr. Phillips joined Northern in 2005 and became co-manager in April, 2011.  He’s one of Northern’s lead asset-allocation specialists.

Management’s Stake in the Fund

None, zero, zip.   The research is pretty clear, that substantial manager ownership of a fund is associated with more prudent risk taking and modestly higher returns.  I checked 15 Northern managers listed in the 2010 Statement of Additional Information.  Not a single manager had a single dollar invested.  For both practical and symbolic reasons, that strikes me as regrettable.

Opening date

Northern Institutional Balanced, this fund’s initial incarnation, launched on July 1, 1993.  On April 1, 2008, this became an institutional fund of funds with a new name, manager and mission and offered four share classes.  On August 1, 2011, all four share classes were combined into a single no-load retail fund but is otherwise identical to its institutional predecessor.

Minimum investment

$2500, reduced to $500 for IRAs and $250 for accounts with an automatic investing plan.

Expense ratio

0.68%, after waivers, on assets of $18 million. While there’s no guarantee that the waiver will be renewed next year, Peter Jacob, a vice president for Northern Trust Global Investments, says that the board has never failed to renew a requested waiver. Since the new fund inherited the original fund’s shareholders, Northern and the board concluded that they could not in good conscience impose a fee increase on those folks. That decision that benefits all investors in the fund. Update – 0.68%, after waivers, on assets of nearly $28 million (as of 12/31/2012.)

Comments

The case for this fund can be summarized easily.  It was a perfectly respectable institutional balanced fund which has become dramatically better as a result of two sets of recent changes.

Northern Institutional Balanced invested conservatively and conventionally.  It held about two-thirds in stocks (mostly mid- to large-sized US companies plus a few large foreign firms) and one-third in bonds (mostly investment grade domestic bonds).   Northern’s ethos is very risk sensitive which makes a world of sense given their traditional client base: the exceedingly affluent.  Those folks didn’t need Northern to make a ton of money for them (they already had that), they needed Northern to steward it carefully and not take silly risks.  Even today, Northern trumpets “active risk management and well-defined buy-sell criteria” and celebrates their ability to provide clients with “peace of mind.”  Northern continues to highlight “A conservative investment approach . . . strength and stability . . .  disciplined, risk-managed investment . . . “

As a reflection of that, Balanced tended to capture only 65-85% of its benchmark’s gains in years when the market was rising but much less of the loss when the market was falling.  In the long-term, the fund returned about 85% of its 65% stock – 35% bond benchmark’s gains but did so with low volatility.

That was perfectly respectable.

Since then, two sets of changes have made it dramatically better.  In April 2008, the fund morphed from conservative balanced to a global tactical fund of funds.  At a swoop, the fund underwent a series of useful changes.

The asset allocation became fluid, with an investment committee able to substantially shift asset class exposure as opportunities changed.

The basic asset allocation became more aggressive, with the addition of a high-yield bond fund and emerging markets equities.

The fund added exposure to alternative investments, including gold, commodities, global real estate and currencies.

Those changes resulted in a markedly stronger performer.  In the three years since the change, the fund has handily outperformed both its Morningstar benchmark and its peer group.  Its returns place it in the top 7% of balanced funds in the past three years (through 8/25/11).  Morningstar has awarded it five stars for the past three years, even as the fund maintained its “low risk” rating.  Over the same period, it’s been designated a Lipper Leader (5 out of 5 score) for Total Returns and Expenses, and 4 out of 5 for Consistency and Capital Preservation.

In the same period (04/01/2008 – 08/26/2011), it has outperformed its peer group and a host of first-rate balanced funds including Vanguard STAR (VGSTX), Vanguard Balanced Index (VBINX), Fidelity Global Balanced (FGBLX), Leuthold Core (LCORX), T. Rowe Price Balanced (RPBAX) and Dodge & Cox Balanced (DODBX).

In August 2011, the fund morphed again from an institutional fund to a retail one.   The investment minimum dropped from $5,000,000 to as low as $250.  The expense ratio, however, remained extremely low, thanks to an ongoing expense waiver from Northern.  The average for other retail funds advertising themselves as “tactical asset” or “tactical allocation” funds is about 1.80%.

Bottom Line

Northern GTA offers an intriguing opportunity for conservative investors.  This remains a cautious fund, but one which offers exposure to a diverse array of asset classes and a price unavailable in other retail offerings.  It has used its newfound flexibility and low expenses to outperform some very distinguished competition.  Folks looking for an interesting and affordable core fund owe it to themselves to add this one to their short-list.

Fund website

Northern Global Tactical Asset Allocation

Update – 3Q2011 Fact Sheet

Fund Profile, 2nd quarter, 2012

2013 Q3 Report

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

Objective and strategy

The fund seeks to provide long-term total return by investing in common and preferred stocks, convertibles and REITs. The manager attempts to invest in high quality, small- to mid-cap firms (those with market caps between $100 million and $5 billion). He thinks of himself as having an “absolute return” mandate, which means an exceptional degree of risk-consciousness. He’ll pursue the same style of investing as in his previous charges, but has more flexibility than before because this fund does not include the “small cap” name.

Adviser

Aston Asset Management, LP. It’s an interesting setup. As of June 30, 2012, Aston is the adviser to twenty-seven mutual funds with total net assets of approximately $10.5 billion and is a subsidiary of the Affiliated Managers Group. River Road Asset Management LLC subadvises six Aston funds; i.e., provides the management teams. River Road, founded in 2005, oversees $7 billion and is a subsidiary of the European insurance firm, Aviva, which manages $430 billion in assets. River Road also manages five separate account strategies, including the Independent Value strategy used here.

Manager

Eric Cinnamond. Mr. Cinnamond is a Vice President and Portfolio Manager of River Road’s independent value investment strategy. Mr. Cinnamond has 19 years of investment industry experience. Mr. Cinnamond managed the Intrepid Small Cap (ICMAX) fund from 2005-2010 and Intrepid’s small cap separate accounts from 1998-2010. He co-managed, with Nola Falcone, Evergreen Small Cap Equity Income from 1996-1998.  In addition to this fund, he manages six smallish (collectively, about $50 million) separate accounts using the same strategy.

Management’s Stake in the Fund

As of October 2011, Mr. Cinnamond has between $100,000 and $500,000 invested in his fund.  Two of Aston’s 10 trustees have invested in the fund.  In general, a high degree of insider ownership – including trustee ownership – tends to predict strong performance.  Given that River Road is a sub-advisor and Aston’s trustees oversee 27 funds each, I’m not predisposed to be terribly worried.

Opening date

December 30, 2010.

Minimum investment

$2,500 for regular accounts, $500 for various sorts of tax-advantaged products (IRAs, Coverdells, UTMAs).

Expense ratio

1.42%, after waivers, on $616 million in assets.

Comments

While some might see a three-month old fund, others see the third incarnation of a splendid 16 year old fund.

The fund’s first incarnation appeared in 1996, as the Evergreen Small Cap Equity Income fund. Mr. Cinnamond had been hired by First Union, Evergreen’s advisor, as an analyst and soon co-manager of their small cap separate account strategy and fund. The fund grew quickly, from $5 million in ’96 to $350 million in ’98. It earned a five-star designation from Morningstar and was twice recognized by Barron’s as a Top 100 mutual fund.

In 1998, Mr. Cinnamond became engaged to a Floridian, moved south and was hired by Intrepid (located in Jacksonville Beach, Florida) to replicate the Evergreen fund. For the next several years, he built and managed a successful separate accounts portfolio for Intrepid, which eventually aspired to a publicly available fund.

The fund’s second incarnation appeared in 2005, with the launch of Intrepid Small Cap (ICMAX). In his five years with the fund, Mr. Cinnamond built a remarkable record which attracted $700 million in assets and earned a five-star rating from Morningstar. If you had invested $10,000 at inception, your account would have grown to $17,300 by the time he left. Over that same period, the average small cap value fund lost money. In addition to a five star rating from Morningstar (as of 2/25/11), the fund was also designated a Lipper Leader for both total returns and preservation of capital.

In 2010, Mr. Cinnamond concluded that it was time to move on. In part he was drawn to family and his home state of Kentucky. In part, he seems to have reassessed his growth prospects with the firm.

The fund’s third incarnation appeared on the last day of 2010, with the launch of Aston / River Road Independent Value (ARIVX). While ARIVX is run using the same discipline as its predecessors, Mr. Cinnamond intentionally avoided the “small cap” name. While the new fund will maintain its historic small cap value focus, he wanted to avoid the SEC stricture which would have mandated him to keep 80% of assets in small caps.

Over an extended period, Mr. Cinnamond’s small cap composite (that is, the weighted average of the separately managed accounts under his charge over the past 15 years) has returned 12% per year to his investors. That figure understates his stock picking skills, since it includes the low returns he earned on his often-substantial cash holdings. The equities, by themselves, earned 15.6% a year.

The key to Mr. Cinnamond’s performance (which, Morningstar observes, “trounced nearly all equity funds”) is achieved, in his words, “by not making mistakes.” He articulates a strong focus on absolute returns; that is, he’d rather position his portfolio to make some money, steadily, in all markets, rather than having it alternately soar and swoon. There seem to be three elements involved in investing without mistakes:

• Buy the right firms.
• At the right price.
• Move decisively when circumstances demand.

All things being equal, his “right” firms are “steady-Eddy companies.” They’re firms with look for companies with strong cash flows and solid operating histories. Many of the firms in his portfolio are 50 or more years old, often market leaders, more mature firms with lower growth and little debt.

Like many successful managers, Mr. Cinnamond pursues a rigorous value discipline. Put simply, there are times that owning stocks simply aren’t worth the risk. Like, well, now. He says that he “will take risks if I’m paid for it; currently I’m not being paid for taking risk.” In those sorts of markets, he has two options. First, he’ll hold cash, often 20-30% of the portfolio. Second, he moves to the highest quality companies in “stretched markets.” That caution is reflected in his 2008 returns, when the fund dropped 7% while his benchmark dropped 29%.

But he’ll also move decisively to pursue bargains when they arise. “I’m willing to be aggressive in undervalued markets,” he says. For example, ICMAX’s portfolio went from 0% energy and 20% cash in 2008 to 20% energy and no cash at the market trough in March, 2009. Similarly, his small cap composite moved from 40% cash to 5% in the same period. That quick move let the fund follow an excellent 2008 (when defense was the key) with an excellent 2009 (where he was paid for taking risks). The fund’s 40% return in 2009 beat his index by 20 percentage points for a second consecutive year. As the market began frothy in 2010 (“names you just can’t value are leading the market,” he noted), he let cash build to nearly 30% of the portfolio. That meant that his relative returns sucked (bottom 10%), but he posted solid absolute returns (up 20% for the year) and left ICMAX well-positioned to deal with volatility in 2011.

Unfortunately for ICMAX shareholders, he’s moved on and their fund trailed 95% of its peers for the first couple months of 2011. Fortunately for ARIVX shareholders, his new fund is leading both ICMAX and its small value peers by a comfortable early margin.

The sole argument against owning is captured in Cinnamond’s cheery declaration, “I like volatility.” Because he’s unwilling to overpay for a stock, or to expose his shareholders to risk in an overextended market, he sidelines more and more cash which means the fund might lag in extended rallies. But when stocks begin cratering, he moves quickly in which means he increases his exposure as the market falls. Buying before the final bottom is, in the short term, painful and might be taken, by some, as a sign that the manager has lost his marbles. He’s currently at 40% cash, effectively his max, because he hasn’t found enough opportunities to fill a portfolio. He’ll buy more as prices on individual stocks because attractive, and could imagine a veritable buying spree when the Russell 2000 is at 350. At the end of February 2011, the index was close to 700.

Bottom Line

Aston / River Road Independent Value is the classic case of getting something for nothing. Investors impressed with Mr. Cinnamond’s 15 year record – high returns with low risk investing in smaller companies – have the opportunity to access his skills with no higher expenses and no higher minimum than they’d pay at Intrepid Small Cap. The far smaller asset base and lack of legacy positions makes ARIVX the more attractive of the two options. And attractive, period.

Fund website

Aston/River Road Independent Value

2013 Q3 Report

2013 Q3 Commentary

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

Objective and Strategy

COBYX pursues the long-term growth of capital.  They do that by assembling an exceedingly concentrated global stock portfolio.  The stocks in the portfolio must meet four criteria.

• Circle of Competence: they only invest in businesses “whose economics and future prospects” they can understand.
• Business: they only invest in “wide moat” firms, those with sustainable competitive advantages.
• People: they only invest when they believe the management team is highly competent and trustworthy.
• Price: they only buy shares priced at a substantial discount – preferably 50% – to their estimate of the share’s true value.

Within those confines, they can invest pretty much anywhere and in any amount.

Adviser

Cook & Bynum Capital Management, LLC, an independent, employee-owned money management firm established in 2001.  The firm is headquartered in Birmingham, Alabama.  It manages COBYX and two other “pooled investment vehicles.”  As of June 30, 2012, the adviser had approximately $220 million in assets under management.

Managers

Richard P. Cook and J. Dowe Bynum.  Messrs Cook and Bynum are the principals and founding partners of Cook & Bynum (are you surprised?) and have managed the fund since its inception. They have a combined 23 years of investment management experience. Mr. Cook previously managed individual accounts for Cook & Bynum Capital Management, which also served as a subadviser to Gullane Capital Partners. Prior to that, he worked for Tudor Investment Corp. in Greenwich, CT. Mr. Bynum also managed individual accounts for Cook & Bynum. Previously, he’d worked as an equity analyst at Goldman Sachs & Co. in New York.   They work alone and also manage around $140 million in two other accounts.

Management’s Stake in the Fund

As of September 30, 2011, Mr. Cook had between $100,000 and $500,000 invested in the fund, and Mr. Bynum had over $500,000 invested.  Between these investments and their investments in the firm’s private accounts, they have “substantially all of our investable net worth” in the firm’s investment vehicles.

Opening date

July 1, 2009.  The fund is modeled on a private accounts which the team has run since August 2001.

Minimum investment

$5,000 for regular accounts and $1,000 for IRA accounts.

Expense ratio

1.88%, after waivers, on assets of $82 million.  There’s also a 2% redemption fee for shares held less than 60 days.

Comments

I can explain what Cook and Bynum do.

I can explain how they’ve done.

But I have no comfortable explanation for how they’ve done it.

Messrs. Cook and Bynum are concentrated value investors in the tradition of Buffett and Munger.  They’ve been investing since before they were teens and even tried to start a mutual fund with $200,000 in seed money while they were in college.  Within a few years after graduating college, they began managing money professionally.  Now in their mid 30s, they’re on the verge of their first Morningstar rating which might well be five stars.

Their investment discipline seems straightforward: do what Warren would do.  Focus on businesses and industries that you understand, invest only with world-class management teams, research intensely, wait for a good price, don’t over-diversify, and be willing to admit your mistakes.

They are, on face, very much like dozens of other Buffett devotees in the fund world.

Their discipline led to the construction of a very distinctive portfolio.  They’ve invested in just eight stocks (as of 3/31/12) and hold about 30% in cash.  There are simply no surprises in the list:

Company	Ticker	Sector	% of Total Portfolio
Wal-Mart Stores	WMT	General Merchandise Stores	19.0
Microsoft	MSFT	Software Publishers	10.8
Berkshire Hathaway	BRK/B	Diversified Companies	10.3
Arca Continental SAB	AC* MM	Soft Drink Bottling & Distribution	8.8
Coca-Cola	KO	Soft Drink Manufacturing	5.2
Procter & Gamble	PG	Household/Cosmetic Products Manufacturing	5.0
Kraft Foods	KFT	Snack Food Manufacturing	4.9
Tesco	TSCO	Supermarkets & Other Grocery Stores	4.9

American investors might be a bit unfamiliar with the fund’s two international holdings (Arca is a large Coca-Cola bottler serving Latin America and Tesco is the world’s third-largest retailer) but neither is “an undiscovered gem.”  With so few stocks, there’s little diversification by sector (70% of the fund is “consumer defensive” stocks) or size (85% are mega-caps).  Both are residues of bottom-up stock picking (that is, the stocks which best met C&B’s criteria were consumer-oriented multinationals) and are of no concern to the managers who remain agnostic about such external benchmarks. The fund’s turnover ratio is 25%, which is quite, if not stunningly, low.

Their performance has, however, been excellent.  Kiplinger’s (11/29/2011) reported on their long-term record: “Over the past ten years through October 31, 2011, a private account the duo have managed in the same way they manage the fund returned 8.7% annualized” which beat the S&P 500 by 6.4% per year.  COBYX just passed its third anniversary with a bang: its returns are in the top 1-5% of its large blend peer group for the past month, quarter, YTD, year and three years.  While the mutual fund trailed the vast majority of its peers in 2010, returning 11.8% versus 14.0% for its peers, that’s both very respectable and not unusual for a cash-heavy fund in a rallying market.  In 2011 the fund finished in the top 1% of its peer group and it was in the top 3% through the first seven months of 2012.

More to the point, the fund has (since inception) substantially outperformed Mr. Buffett’s Berkshire-Hathaway (BRK.A).  It is well ahead of other focus Buffettesque funds such as Tilson Focus (TILFX) and FAM Value (FAMVX) and while it has returns in the neighborhood of Tilson Dividend (TILDX), Yacktman (YACKX) and Yacktman Focused (YAFFX), it’s less volatile.

Having read about everything written by or about the fund and having spoken at length with David Hobbs, Cook & Bynum’s president, I’m still not sure why they do so well.  What stands out from that conversation is the insane amount of fieldwork the managers do before initiating and while monitoring a position.  By way of example, the fund invested in Wal-Mart de Mexico (Walmex) from 2007-2012.  Their interest began while they were investigating another firm (Soriana), whose management idolized Walmex.  “We visited Walmex’s management the following week in Mexico City and were blown away … Since then we have made hundreds of store visits to Walmex’s various formats as well as to Soriana’s and to those of other competitors…”  They concluded that Walmex was “perhaps the finest large company in the world” and its stock was deeply discounted.  They bought.   The Walmex position “significantly outperformed our most optimistic expectation over the last six years,” with the stock rising high enough that it no longer trades at an adequate discount so they sold it.

In talking with Mr. Hobbs, it seems that a comparable research push is taking place in emerging Europe.  While the team suspects that the Eurozone might collapse, such macro calls don’t drive their stock selection and so they’re pursuing a number of leads within the zone.  Given their belief in a focused portfolio, Hobbs concluded “if we can find two or three good ideas, it’s been a good year.”

Potential investors need to cope with three concerns.  First, a 1.88% expense ratio is high and is going to be an ongoing drag on returns.  Second, their incessant travel carries risks.  In psychology, the problem is summed up in the adage, “seek and ye shall find, whether it’s there or not.”  In acoustical engineering, it’s addressed as the “signal-to-noise ratio.”  If you were to spend three weeks of your life schlepping around central Europe, perusing every mini-mart from Bratislava to Bucharest, you’d experience tremendous internal pressure to conclude that you’d gained A Great Insight from all that effort. Third, it’s not always going to work.  For all their care and skill, someone will slip Stupid Pills into their coffee one morning.  It happened to Donald Yacktman, a phenomenally talented guy who trailed his peers badly for three consecutive years (2004-06).  It happened to Bill Nygren whose Oakmark Select (OAKLX) crushed for a decade then trailed the pack, sometimes dramatically, for five consecutive years (2003-07).  Over 30 years it happens repeatedly to Marty Whitman at Third Avenue Value (TAVFX). And it happened to a bunch of once-untouchable managers (Jim Oelschlager at White Oak Growth WOGSX, Auriana and Utsch at Kaufmann KAUFX, Ron Muhlenkamp at Muhlenkamp Fund MUHLX) whose former brilliance is now largely eclipsed.  The best managers stumble and recover.  The best focused portfolio managers stumble harder, and recover.  The best shareholders stick with them.

Bottom Line

It’s working.  Cook and Bynum might well be among the best.  They’re young.  The fund is small and nimble.  Their discipline makes great sense.  It’s not magic, but it has been very, very good and offers an intriguing alternative for investors concerned by lockstep correlations and watered-down portfolios.

Fund website

The Cook & Bynum Fund.  The C&B website was recently recognized as one of the two best small fund websites as part of the Observer’s “Best of the Web” feature.

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

Objective and Strategy

FPA International Value tries to provide above average capital appreciation over the long term while minimizing the risk of capital losses.  Their strategy is to identify high-quality companies, invest in a quite limited number of them and only when they’re selling at a substantial discount to FPA’s estimation of fair value, and then to hold on to them for the long-term.  In the absence of stocks selling at compelling discounts, FPA is willing to hold a lot of cash for an extended period.  They’re able to invest in both developed and developing markets, but recognize that the bulk of their exposure to the latter might be achieved indirectly through developed market firms with substantial emerging markets footprints.

Adviser

FPA, formerly First Pacific Advisors, which is located in Los Angeles.  The firm is entirely owned by its management which, in a singularly cool move, bought FPA from its parent company in 2006 and became independent for the first time in its 50 year history.  The firm has 25 investment professionals and 66 employees in total.  Currently, FPA manages about $20 billion across four equity strategies and one fixed income strategy.  Each strategy is manifested in a mutual fund and in separately managed accounts; for example, the Contrarian Value strategy is manifested in FPA Crescent (FPACX), in nine separate accounts and a half dozen hedge funds.

Managers

Pierre O. Py.  Mr. Py joined FPA in September 2011. Prior to that, he was an International Research Analyst for Harris Associates, adviser to the Oakmark funds, from 2005 to 2010.  At this writing (July 30 2012), Mr. Py was looking for a couple of analysts to assist in running the fund.

Management’s Stake in the Fund

Mr. Py, his former co-manager Eric Bokota and FPA’s partners are the fund’s largest investors.  Mr. Bokota estimated that he and Mr. Py had invested about two to three times their annual salary in the fund.  That reflects FPA’s corporate commitment to “co-investment” in which “Partners invest alongside our clients and have a majority of their investable net worth committed to the firm’s products and investments. We encourage all other members of the firm to invest similarly.”

Opening date

December 1, 2011.

Minimum investment

$1,500, reduced to $100 for IRAs or accounts with automatic investing plans

Expense ratio

1.35% on assets of $8 million

Comments

Few fund companies get it consistently right.  By “right” I don’t mean “in step with current market passions” or “at the top of the charts every years.”  By “right” I mean two things: they have an excellent investment discipline and they treat their shareholders with profound respect.

FPA gets it consistently right.

That alone is enough to warrant a place for FPA International Value on any reasonable investor’s due diligence list.

What are the markers of getting it right?  FPA describes itself as a “absolute value investors.”  They simply refuse to buy overpriced assets, preferring instead to hold cash – even at negligible yields – rather than lowering their standards.  It’s not unusual for an FPA fund to hold 20 – 40% in cash, sometimes for several years.  That means the funds will sometimes post disastrous relative returns – for example, flagship FPA Capital (FPTTX) has trailed 98-100% of its peers three times in the past ten years – but their refusal to buy anything at frothy prices pays off handsomely for long-term investors (FPPTX has posted top-tier results for the decade as a whole).  That divergence between occasional short-term dislocations and long-term discipline leads to an interesting pattern in Morningstar ratings: while three of FPA’s four established stock funds earn just three stars (as of late July 2012), all three also earn Silver ratings which reflects the judgment of Morningstar’s analysts that these really are top-tier funds.

The fourth fund, Steve Romick’s FPA Crescent (FPACX), earns both five stars and a Gold analyst rating.

Like the other FPA funds, FPA International Value is looking to buy world-class companies at substantial discounts.

We always demand that our investments meet the following criteria:

1. High quality businesses with long-term staying power.
2. Overall financial strength and ability to weather market dislocations.
3. Management teams that allocate capital in a value creative manner.
4. Significant discount to the intrinsic value of the business.

The managers will follow a good company for years if necessary, waiting for an opportunity to purchase its stock at a price they’re willing to pay.  Founding co-manager Eric Bokota said that they’d purchase if the discount to fair value was at least 33% but would begin “lightening up” on the position while the discount narrowed to 17%; that is, they buy deeply discounted stocks and begin to sell modestly discounted ones.

Mr. Bokota argues that the long-term success of the strategy rises as market volatility rises.  First, the managers have been assessing possible purchase targets for years, in many cases.  Part of that assessment is how corporate management handles “market dislocations.”  Bokota’s argument is that short-term dislocations strengthen the best companies by giving them the opportunity to acquire less-seasoned competitors or to acquire market share from them.  Second, their willingness to hold cash (around 22% of the portfolio, as of the end of July 2012) means that they have the resources to act when the time is right and an automatic cushion when the time isn’t.

Bokota holds that the fund has four competitive distinctions:

1. It holds stocks of all sizes, from $400 million to multinational mega-caps
2. It holds cash rather than lower quality or higher cost stocks
3. It maintains its absolute value orientation in all markets
4. It is unusually concentrated, with a target of 25-35 names in the portfolio.  As of late July, the portfolio is just below 25 names.  That’s consistent in line with Mr. Bokota’s observation that “anything north of 15 to 20 names” offers about as much diversification benefit as you’re going to get.

The fund’s early performance (top 1% of its peer group for the first seven months of 2012 with muted volatility) is entirely encouraging.  That said, there are three reasons for caution:

First, the management team is still evolving.  The fund launched in December 2011 with two co-managers, Eric Bokota and Pierre Py.  Both were analysts at Harris/Oakmark and they shared responsibility for the portfolio.  They were not supported by any research analysts, which Bokota described as a manageable arrangement because their universe of investable stocks is quite small and both he and Py loved research.  In July 2012, Mr. Bokota suddenly resigned for pressing personal reasons.  Py and FPA immediately began a search for two analysts, one of whom spokesman Ryan Leggio described as “a senior analyst.”  Their hope was to have the matter settled by the end of the summer, but the question was open at the time of this writing.

Second, this is the manager’s first fund.  While Mr. Py doubtless excelled as a member of Oakmark’s well-respected analyst corps, he has not previously been the lead guy and hasn’t had to deal with the demands of marketing and of fickle investors.

Third, FPA’s discipline lends itself to periods of dismal relative performance especially during sharply rising markets.  Sadly, rising markets are when investors are most willing to check portfolios daily and most likely to dump what they perceive to be “laggards.”  Investors with relatively high turnover fund portfolio (folks who “actively manage” their portfolios by trading funds in search of what’s hot) are likely to be poorly served by FPA’s steady discipline.

Bottom Line

FPA lends a fine pedigree to this fund, their first new offering in almost 20 years (they acquired Crescent in the early 1990s) and their first new fund launch in almost 30.  While the FPIVX team has considerable autonomy, it’s clear that they also believe passionately in FPA’s absolute value orientation and are well-supported by their new colleagues.  While FPIVX certainly will not spend every year in the top tier and will likely spend some years in the bottom one, there are few with better long-term prospects.

Fund website

FPAInternationalValue

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

Objective and Strategy

SFGIX seeks to provide long-term capital appreciation along with some current income; it also seeks to mitigate adverse volatility in returns. The Fund invests a significant amount of its net assets in the securities of companies located in developing countries. The Fund can invest in dividend-paying common stocks, preferred stocks, convertible bonds, and fixed-income securities.  The fund will invest 20-50% in developed markets and 50-80% in developing and frontier markets worldwide.

Adviser

Seafarer Capital Partners of San Francisco.  Seafarer is a small, employee-owned firm whose only focus is the Seafarer fund.

Managers

Andrew Foster is the lead manager and is assisted by William Maeck.  Mr. Foster is Seafarer’s founder and Chief Investment Officer.  Mr. Foster formerly was manager or co-manager of Matthews Asia Growth & Income (MACSX) and Matthews’ research director and acting chief investment officer.  He began his career in emerging markets in 1996, when he worked as a management consultant with A.T. Kearney, based in Singapore, then joined Matthews in 1998.  Andrew was named Director of Research in 2003 and served as the firm’s Acting Chief Investment Officer during the height of the global financial crisis, from 2008 through 2009.  Mr. Maeck is the associate portfolio manager and head trader for Seafarer.  He’s had a long career as an investment adviser, equity analyst and management consultant.  They are assisted by an analyst with deep Latin America experience.

Management’s Stake in the Fund

Mr. Foster has over $1 million in the fund.  Both his associate manager and senior research analyst have substantial investments in the fund.

Opening date

February 15, 2012

Minimum investment

$2,500 for regular accounts and $1000 for retirement accounts. The minimum subsequent investment is $500.

Expense ratio

1.60% after waivers on assets of $5 million (as of June, 2012).  The fund does not charge a 12(b)1 marketing fee but does have a 2% redemption fee on shares held fewer than 90 days.

Comments

The case for Seafarer is straightforward: it’s going to be one of your best options for sustaining exposure to an important but challenging asset class.

The asset class is emerging markets equities, primarily.  The argument for emerging markets exposure is well-known and compelling.  The emerging markets represent the single, sustainable source of earnings growth for investors.  As of 2010, emerging markets represented 30% of the world’s stock market capitalization but only 6% of the average American investor’s portfolio.  During the first (so-called “lost”) decade of the 21st century, the MSCI emerging markets stock index doubled in price. An analysis by Goldman projects that, over the next 20 years, the emerging markets will account for 55% of the global stock market and that China will be the world’s single largest market.  That’s consistent with GMO’s May 2012 7-year asset class return forecast, which projects a 6.7% real (i.e. inflation-adjusted) annual return for emerging equities but less than 1% for the U.S. stock market as a whole.  Real returns on emerging debt were projected at 1.7% while U.S. bonds were projected to lose money over the period.

Sadly, the average investor seems incapable of profiting from the potential of the emerging markets, seemingly because of our hard-wired aversion to loss.  Recent studies by Morningstar and Dalbar substantiate the point.  John Rekenthaler’s “Myth of the Dumb Fund Investor” (June 2012) looks at a decade’s worth of data and concludes that investors tend to pick the better fund within an asset class while simultaneously picking the worst asset classes (buying small caps just before a period of large cap outperformance).  Dalbar’s  Quantitative Analysis of Investor Behavior (2012) looks at 20 years of data and concluded that equity investors’ poor timing decisions cost them 2-6% annually; that is, the average equity investor trails the broad market by about that much.

The situation with emerging markets investing appears far worse.  Morningstar calculates “investor returns” for many, though not all, funds.  Investor returns take into account a fund’s asset size which allows Morningstar to calculate whether the average investor was around during a fund’s strongest years or its weakest.  In general, investors sacrifice 65-75% of their potential returns through bad (fearful or greedy) timing. That’s based on a reading of 10-year investor versus fund returns.  For T Rowe Price E. M. Stock (PRMSX), for example, the fund returned 12% annually over the last decade while the average investor earned 3%.  For the large but low-rated Fidelity E.M. (FEMKX), the fund returned 10.5% while its investors made 3.5%.

Institutional investors were not noticeably more rational.  JPMorgan Emerging Markets Equities Institutional (JMIEX) and Lazard Emerging Markets Equity Institutional (LZEMX) posted similar gaps.  The numbers for DFA, which carefully vets and trains its clients, were wildly inconsistent: DFA Emerging Markets I (DFEMX) showed virtually no gap while DFA Emerging Markets II (DFETX) posted an enormous one.  Rekenthaler also found the same weaknesses in institutional investors as he did in retail ones.

There is, however, one fund that stands in sharp contrast to this dismal general pattern: Matthews Asian Growth & Income (MACSX), which Andrew Foster co-managed or managed for eight years.  Over the past decade, the fund posted entirely reasonable returns: about 11.5% per year (through June 2012).  MACSX’s investors did phenomenally well.  They earned, on average. 10.5% for that decade. That means they captured 91% of the fund’s gains.  Over the past 15 years, the results are even better with investors capturing essentially 100% of the fund’s returns.

The great debate surrounding MACSX was whether it was the best Asia-centered fund in existence or merely one of the two or three best funds in existence.  Here’s the broader truth within their disagreement: Mr. Foster’s fund was, consistently and indisputably one of the best Asian funds in existence.

The fund married an excellent strategy with excellent execution. Based on his earlier research, Mr. Foster believes that perhaps two-thirds of MACSX’s out-performance was driven by having “a more sensible” approach (for example, recognizing the strategic errors embedded in the index benchmarks which drive most “active” managers) and one-third by better security selection (driven by intensive research and over 1500 field visits).  Seafarer will take the MACSX formula global.  It is arguable that that Mr. Foster can create a better fund at Seafarer than he had at Matthews.

One key is geographic diversification.  As of May 31, 2012, Seafarer had an 80/20 split between developing Asia and the rest of the world.  Mr. Foster argues that it makes sense to hold an Asia-centered portfolio.  Asia is one of the world’s most dynamic regions and legal protections for investors are steadily strengthening.  It will drive the world’s economy over decades.  In the shorter term, while the inevitable unraveling of the Eurozone will shake all markets, “Asia may be able to withstand such losses best.”

That said, a purely Asian portfolio is less attractive than an Asia-centered portfolio with selective exposure to other emerging markets.  Other regions are, he argues, undergoing the kind of changes now than Asia underwent a generation ago which might offer the prospect of outsized returns.  Some of the world’s most intriguing markets are just now becoming investable while others are becoming differently investable: while Latin America has long been a “resources play” dependent on Asian customers, it’s now developing new sectors(think “Brazilian dental HMOs”) and new markets whose value is not widely recognized.  In addition, exposure to those markets will buffer the effects of a Chinese slowdown.

Currently the fund invests almost-exclusively in common stock, either directly or through ADRs and ETFs.  That allocation is driven in part by fundamentals and in part by necessity.  Fundamentally, emerging market valuations are “very appealing.”  Mr. Foster believes that there have only been two occasions over the course of his career – during the 1997 Asian financial crisis and the 2008 global crisis – that “valuations were definitively more attractive than at present” (Shareholder Letter, 18 May 2012). That’s consistent with GMO’s projection that emerging equities will be the highest-returning asset class for the next five-to-seven years.  As a matter of necessity, the fund has been too small to participate in the convertible securities market.  With more assets under management, it gains the flexibility to invest in convertibles – an asset class that substantially strengthened MACSX’s performance in the past.  Mr. Foster has authority to add convertibles, preferred shares and fixed income when valuations and market conditions warrant.  He was done so skillfully throughout his career.

Seafarer’s returns over its first two quarters of existence (through 29 June 2012) are encouraging.  Seafarer has substantially outperformed the diversified emerging markets group as a whole, iShares Asia S&P 50 (AIA) ETF, First Trust Aberdeen Emerging Opportunities fund(FEO) which is one of the strongest emerging markets balanced funds, the emerging Asia, Latin America and Europe benchmarks, an 80/20 Asia/non-Asia benchmark, and so on.  It has closely followed the performance of MACSX, though it ended the period trailing by a bit.

Bottom Line

Mr. Foster is remarkably bright, thoughtful, experienced and concerned about the welfare of his shareholders.  He grasps the inefficiencies built into standard emerging markets indexes, and replicated by many of the “active” funds that are benchmarked to them. He’s already navigated the vicissitudes of a region’s evolution from uninvestable to frontier, emerging and near-developed.   He believes that experience will serve his shareholders “when the world’s falling apart but you see how things fit together.” He’s a good manager of risk, which has made him a great manager of returns.  The fund offers him more flexibility than he’s ever had and he’s using it well.  There are few more-attractive emerging markets options available.

Fund website

Seafarer Overseas Growth and Income.  The website is remarkably rich, both with analyses of the fund’s portfolio and performance, and with commentary on broader issues.

Disclosure

In mid-July, about two weeks after this profile is published, I’ll purchase shares of Seafarer for my personal, non-retirement account.  I’ll sell down part of my existing MACSX stake to fund that purchase.

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

Objective and Strategy

ARLSX seeks to provide absolute returns (“equity-like returns,” they say) while minimizing volatility over a full market cycle.  The fund invests, long and short, mostly in US common stocks but can also take positions in foreign stock, preferred stock, convertible securities, REITs, ETFs, MLPs and various derivatives. The fund is not “market neutral” and will generally be “net long,” which is to say it will have more long exposure than short exposure.  The managers have a strict, quantitative risk-management discipline that will force them to reduce equity exposure under certain market conditions.

Adviser

Aston Asset Management, LP, which is based in Chicago.  Aston’s primary task is designing funds, then selecting and monitoring outside management teams for those funds.  As of March 31, 2012, Aston has partnered with 18 subadvisers to manage 26 mutual funds with total net assets of approximately $10.7 billion. Aston funds are available to retail investors, as well as through various professional channels.

Managers

Matt Moran and Daniel Johnson.  Both work for River Road Asset Management, which is based in Louisville.    They manage money for a variety of private clients (cities, unions, corporations and foundations) and sub-advise five funds for Aston, including the splendid (and closed) Aston/River Road Independent Value (ARIVX).  River Road employs 39 associates including 15 investment professionals.   Mr. Moran is the lead manager, joined River Road in 2007, has about a decade’s worth of experience and is a CFA.  Before joining River Road, he was an equity analyst for Morningstar (2005-06), an associate at Citigroup (2001-05), and an analyst at Goldman Sachs (2000-2001).  His MBA is from the University of Chicago.  Mr. Johnson is a CPA and a CFA.  Before joining River Road in 2006, he worked at PricewaterhouseCoopers.

Management’s Stake in the Fund

Mr. Moran and Mr. Johnson had between $100,000 and $500,000 as of April 30, 2012.  Those investments represent a significant portion of the managers’ liquid net worth.

Opening date

May 4, 2011.

Minimum investment

$2,500 for regular accounts and $500 for retirement accounts.

Expense ratio

2.75%, after waivers, on assets of $5.5 million.   The fund’s operating expenses are capped at 1.70%, but expenses related to shorting add another 1.05%.  Expenses of operating the fund, before waivers, are 8.7%.

Comments

Long/short investing makes great sense in theory but, far too often, it’s dreadful in practice.  After a year, ARLSX seems to be getting it right and its managers have a pretty cogent explanation for why that will continue to be the case.

Here’s the theory: in the long term, the stock market rises and so it’s wise to be invested in it.  In the short term, it can be horrifyingly irrational and so it’s wise to buffer your exposure.  That is, you want an investment that is hedged against market volatility but that still participates in market growth.

River Road pursues that ideal through three separate disciplines: long stock selection, short stock selection and level of net market exposure.

In long stock selection, their mantra is “excellent companies trading at compelling prices.” Between 50% and 100% of the portfolio is invested long in 15-30 stocks.

For training and other internal purposes, River Road’s analysts are responsible for creating and monitoring a “best ideas” pool, and Mr. Moran estimates that 60-90% of his long exposure overlaps that pool’s.  They start with conventional screens to identify a pool of attractive stocks.  Within their working universe of 200-300 such stocks, they look for fundamentally attractive companies (those with understandable businesses, good management, clean balance sheets and so on) priced at a discount that their absolute value.  They allow themselves to own the 15-30 most attractive names in that universe.

In short stock selection, they target “challenged business models with high valuations and low momentum.”  In this, they differ sharply from many of their competitors.  They are looking to bet against fundamentally bad companies, not against good companies whose stock is temporarily overpriced.  They can be short with 10-90% of the portfolio and typically have 20-40 short positions.

Their short universe is the mirror of the long universe: lousy businesses (unattractive business models, dunderheaded management, a history of poor capital allocation, and favorites of Wall Street analysts) priced at a premium to absolute value.

Finally, they control net market exposure, that is, the extent to which they are exposed to the stock market’s gyrations.  Normally the fund is 50-70% net long, though exposure could range from 10-90%.

The managers have a “drawdown plan” in place which forces them to become more conservative in the face of sharp market places.  While they are normally 50-70% long, if their portfolio has dropped by 4% they must reduce net market exposure to no more than 50%.  A 6% portfolio decline forces them down to 30% market exposure and an 8% portfolio decline forces them to 10% market exposure.  They achieve the reduced exposure by shorting the S&P500 via the SPY exchange-traded fund; they do not dump portfolio securities just to adjust exposure.  They cannot increase their exposure again until the Russell 3000’s 50 day moving average is positive.  Only after 10 consecutive positive days can they exit the drawdown plan altogether.

Mr. Moran embraces Benjamin Graham’s argument that “The essence of investment management is the management of risks, not the management of returns.”  As a result, they’ve built in a series of unambiguous risk-management measures.  These include:

• A prohibition on averaging down or doubling-down on falling stocks
• Stop loss orders on every long and short position
• A requirement that they begin selling losing positions when losses develop
• A prohibition on shorting stocks that show strong, positive momentum regardless of how ridiculous the stock might otherwise be
• A requirement to systematically reduce any short position when the stock shows positive momentum for five days, and
• The market-exposure controls embedded in the drawdown plan.

The fund’s early results are exceedingly promising.  Over its first full year of existence, the fund returned 3.7%; the S&P500 returned 3.8% while the average long-short fund lost 3.5%.  That placed the first in the top 10% of its category.  River Road’s Long-Short Strategy Composite, the combined returns of its separately-managed long-short products, has a slightly longer record (it launched in July 1, 2010) and similar results: it returned 16.3% through the end of the first quarter of 2012, which trailed the S&P500 (which returned 22.0%) but substantially outperformed the long-short group as a whole (4.2%).

The strategy’s risk-management measures are striking.  Through the end of Q1 2012, River Road’s Sharpe ratio (a measure of risk-adjusted returns) was 1.89 while its peers were at 0.49.  Its maximum drawdown (the drop from a previous high) was substantially smaller than its peers, it captured less of the market’s downside and more of its upside, in consequence of which its annualized return was nearly four times as great.

It also substantially eased the pain on the market’s worst days.  The Russell 3000, a total stock market index, lost an average of 3.6% on its fifteen worst days between the strategy’s launch and the end of March, 2012.  On those same 15 days, River Road lost 0.9% on average – which is to say, its investors dodged 75% of the pain on the market’s worst days.

This sort of portfolio strategy is expensive.  A long-short fund’s expenses come in the form of those it can control (fees paid to management) and those it cannot (expenses such as repayment of dividends generated by its short positions).  At 2.75%, the fund is not cheap but the controllable fee, 1.7% after waivers, is well below the charges set by its average peer.  With changing market conditions, it’s possible for the cost of shorting to drop well below 1% (and perhaps even become an income generator). With the adviser absorbing another 6% in expenses as a result of waivers, it’s probably unreasonable to ask for lower.

Bottom Line

Long-term investors need exposure to the stock market; no other asset class offers the same potential for long-term real returns.  But combatting our human impulse to flee at the worst possible moment requires buffering that exposure.  With the deteriorating attractiveness of the traditional buffer (bonds), investors need to consider non-traditional ones.  There are few successful, time-tested funds available to retail investors.  Among the crop of newer offerings, few are more sensibly-constructed or carefully managed that ARLSX seems to be.  It deserves attention.

Fund website

ASTON / River Road Long-Short Fund

2013 Q3 Report

2013 Q3 Commentary

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

This fund has been liquidated.

Objective

The fund’s investment objective is capital appreciation which it pursues by maintaining long and short equity positions.  It typically invests in domestic stocks (92% as of the last portfolio) and typically targets stocks with market caps of at least $100 million.  The managers look at both industry and individual stock prospects when determining whether to invest, long or short.  The managers may, at any point, position the fund as net long or net short.  It is not designed to be a market neutral offering.

Adviser

Wasatch Advisors of Salt Lake City, Utah.  Wasatch has been around since 1975. It both advises the 19 Wasatch funds and manages money for high net worth individuals and institutions. Across the board, the strength of the company lies in its ability to invest profitably in smaller (micro- to mid-cap) companies. As May 2012, the firm had $11.8 billion in assets under management.

Managers

Ralph Shive and Mike Shinnick. Mr. Shinnick is the lead manager for this fund and co-manages Wasatch Large Cap Value (formerly Equity Income) and 18 separate accounts with Mr. Shive.  Before joining Wasatch, he was a vice president and portfolio manager at 1^st Source Investment Advisers, this fund’s original home. Mr. Shive was Vice President and Chief Investment Officer of 1st Source when this fund was acquired by Wasatch. He has been managing money since 1975 and joined 1st Source in 1989. Before that, he managed a private family portfolio inDallas,Texas.

Management’s Stake in the Fund

Mr. Shinnick has over $1 million in the fund, a substantial increase in the past three years.  Mr. Shive still has between $100,000 and $500,000 in the fund.

Opening date

August 1, 2003 as the 1^st Source Monogram Long/Short Fund, which was acquired by Wasatch and rebranded on December 15, 2008.

Minimum investment

$2,000 for regular accounts, $1,000 for retirement accounts and for accounts which establish automatic investment plans.

Expense ratio

1.63% on assets of $1.2 billion.  There’s also a 2% redemption fee on shares held for fewer than 60 days.

Our Original Comments

Long/short funds come in two varieties, and it’s important to know which you’re dealing with.  Some long/short funds attempt to be market neutral, sometimes advertised as “absolute returns” funds.  They want to make a little money every year, regardless of whether the market goes up or down.  They generally do this by building a portfolio around “paired trades.”  If they choose to invest in the tech sector, they’ll place a long bet on the sector’s most attractive stock and exactly match that it with a short bet on the sector’s least attractive stock.  Their expectation is that one of their two bets will lose money but, in a falling market, they’ll make more by the short on the bad stock than they’ll lose in the long position on the good stock.  Vice versa in a rising market: their long position will, they hope, make more than the short position loses.  In the end, investors pocket the difference: frequently something in the middle single digits.

The other form of long/short fund plays an entirely different game.  Their intention is to outperform the stock market as a whole, not to continually eke out small gains.  These funds can be almost entirely long, almost entirely short, or anywhere in between.  The fund uses its short positions to cushion losses in falling markets, but scales back those positions to avoid drag in rising ones.  These funds will lose money when the market tanks but, with luck and skill, they’ll lose a lot less than an unhedged fund will.

It’s reasonable to benchmark the first set of funds against a cash-equivalent, since they’re trying to do about the same thing that cash does.  It’s reasonable to benchmark the second set against a stock index, since they aspire to outperform such indexes over the long term.  It’s probably not prudent, however, to benchmark them against each other.

Wasatch Long/Short is an example of the second type of fund: it wants to beat the market with dampened downside risk.  Just as Oakmark’s splendid Oakmark Equity & Income (OAKBX) describes itself as “Oakmark with an airbag,” you might consider FMLSX to be “Wasatch Large Cap Value with an airbag.”  The managers write, “Our strategy is directional rather than market neutral; we are trying to make money with each of our positions, rather than using long and short positions to eliminate the impact of market fluctuations.”

Which would be a really, really good thing.  FMLSX is managed by the same guys who run Wasatch Large Cap Value, a fund in which you should probably be invested.  In profiling FMIEX last year, I noted:

Okay, okay, so you could argue that a $600-700 million dollar fund isn’t entirely “in the shadows.” . . . the fact that Fidelity has 20 funds in the $10 billion-plus range all of which trail FMIEX – yes, that includes Contrafund, Low-Priced Stock, Magellan, Growth Company and all – argues strongly for the fact that Mr. Shive’s charge deserves substantially more investor interest than it has received.

As a matter of fact, pretty much everyone trails this fund. When I screened for funds with equal or better 1-, 3-, 5- and 10-year records, the only large cap fund on the list was Ken Heebner’s CGM Focus (CGMFX).  In any case, a solid 6000 funds trail Mr. Shive’s mark and his top 1% returns for the past three-, five- and ten-year periods.

Since then, CGMFocus has tanked while two other funds – Amana Growth (AMAGX) and Yacktman Focused (YAFFX) – joined FMIEX in the top tier.  That’s an awfully powerful, awfully consistent record especially since it was achieved with average to below-average risk.

Which brings us back to the Long/Short fund.  Long/Short uses the same investment discipline as does Large Cap Value.  It just leverages that discipline to create bets against the most egregious stocks it finds, as well as its traditional bets in favor of its most attractive finds.  So far, that strategy has allowed it to match most of the market’s upside and dodge most of its downside.  Over the past three years, Long/Short gained 3.6% annually while Large Cap Value lost 3.9% and the Total Stock Market lost 8.2%.  The more impressive feat is that over the past three months – during one of the market’s most vigorous surges in a half century – Long/Short gained 21.2% while Income Equity gained 21.8%.  The upmarket drag of the short positions was 0.6% while the downside cushion was ten times greater.

That’s pretty consistently true for the fund’s quarterly returns over the past several years.  In rising markets, Long/Short makes money though trailing its sibling by 2-4 percent (i.e., 200-400 basis points).  In failing markets, Long/Short loses 300-900 basis points less.  While the net effect is not to “guarantee” gains in all markets, it does provide investors with ongoing market exposure and a security blanket at the same moment.

Bottom Line

Lots of seasoned investors (Leuthold and Grantham among them) believe that we’ve got years of a bear market ahead of us.  In their view, the price of the robustly rising market of the 80s and 90s will be the stumbling, tumbling markets of this decade and part of the next. Such markets are marked by powerful rallies whose gains subsequently evaporate.  Messrs. Shive and Shinnick share at least part of that perspective.  Their shareholder letters warn that we’re in “a global bear market,” that the spring surge does not represent “the beginning of an upward turn in the market’s cycle,” and that prudence dictates that they “not get too far from shore.”

An investor’s greatest enemy in such markets is panic: panic about being in a falling market, panic about being out of a rising market, panic about being panicked all the time.  While a fund such as FMLSX can’t eliminate all losses, it may allow you to panic less and stay the course just a bit more.  With seasoned management, lower-than-average expenses and a low investment minimum, FMLSX is one of the most compelling choices in this field.

Fund website

Wasatch Long-Short Fund

Fact Sheet

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

Objective

The fund pursues the reassuring objective of long-term total returns and capital preservation.  The plan is to shift allocation between equity and debt based on management’s judgment of the asset class which offers the best risk-return balance.  Equity can range from 25 – 75% of the portfolio, likewise debt.  Both equity and debt are largely unconstrained, that is, the managers can buy pretty much anything, anywhere.  The two notable restrictions are minor: no more than 50% of the total portfolio can be invested outside the U.S. and no more than 15% may be invested in Master Limited Partnerships, which are generally energy and natural resources investments.

Adviser

Osterweis Capital Management.  Osterweis Capital Management was founded in 1983 by John Osterweis to manage money for high net worth individuals, foundations and endowments.   They’ve got $5.3 billion in assets under management (as of March 31 2012), and run both individually managed portfolios and three mutual funds.

Manager

John Osterweis, Matt Berler and Carl Kaufman lead a team that includes the folks (John Osterweis, Matthew Berler, Alexander (Sasha) Kovriga, Gregory Hermanski, and Zachary Perry) who manage Osterweis Fund (OSTFX) and those at the Osterweis Strategic Income Fund (Carl Kaufman and Simon Lee).  The team members have all held senior positions with distinguished firms (Robertson Stephens, Franklin Templeton, Morgan Stanley, Merrill Lynch). Osterweis Fund earned Morningstar’s highest commendation: it has been rated “Gold” in the mid-cap core category.

Management’s Stake in the Fund

Mr. Osterweis had over $1 million in the fund, three of the managers had between $500,000 and $1 million in the fund (as of the most recent SAI, March 30, 2011) while two others had between $100,000 and $500,000.

Opening date

August 31, 2010.

Minimum investment

$5000 for regular accounts, $1500 for IRAs

Expense ratio

1.50%, after waivers, on assets of $43 million (as of April 30 2012).  There’s also a 2% redemption fee on shares held under one month.

Comments

There are, broadly speaking, two sorts of funds which mix both stocks and bonds in their portfolios.  One sort, often simply called a “balanced” fund, sticks with a mix that changes very little over time: 60% stocks (give or take a little) plus 40% bonds (give or take a little), and we’re done.  I’ve written elsewhere, for example in my profile of LKCM Balanced, of the virtue of such funds.  They tend to be inexpensive, predictable and reassuringly dull.  An excellent anchor for a portfolio.

The second sort, sometimes called an “allocation” fund, allows its manager to shift assets between categories, often dramatically.  These funds are designed to allow the management team to back away from a badly overvalued asset class and redeploy into an undervalued one.  Such funds tend to be far more troubled than simple balanced funds for two reasons.  First, the manager has to be right twice rather than once.  A balanced manager has to be right in his or her security selection.  An allocation manager has to be right both on the weighting to give an asset class (and when to give it) and on the selection of stocks or bonds within that portion of the portfolio.  Second, these funds can carry large visible and invisible expenses.  The visible expenses are reflected in the sector’s high expense ratios, generally 1.5 – 2%.  The funds’ trading, within and between sectors, invisibly adds another couple percent in drag though trading expenses are not included in the expense ratio and are frequently not disclosed.

Why consider these funds at all?

If you believe that the market, like the global climate, seems to be increasingly unstable and inhospitable, it might make sense to pay for an insurance policy against an implosion in one asset class or one sector.  PIMCO, for example, has launched of series of unconstrained, all-asset, all-authority funds designed to dodge and weave through the hard times.  Another option would be to use the services of a good fee-only financial planner who specializes in asset allocation.  In either case, you’re going to pay for access to the additional “dynamic allocation” expertise.  If the manager is good (see, for example, Leuthold Core LCORX and FPA Crescent FPACX), you’ll receive your money’s worth and more.

Why consider Osterweis Strategic Investment?

There are two reasons.  First, Osterweis has already demonstrated sustained competence in both parts of the equation (asset allocation and security selection).  Osterweis Strategic Investment is essentially a version of the flagship Osterweis Fund (OSTFX).  OSTFX is primarily a stock fund, but the managers have the freedom to move decisively into bonds and cash if need be.  In the last eight years, the fund’s lowest stock allocation was 60% and highest was 93%, but it tends to have a neutral position in the mid-80s.  Management has used that flexibility to deliver solid long-term returns (nearly 12% over the past 15 years) with far less volatility than the stock market’s.  The second Osterweis Fund, Osterweis Strategic Income (OSTIX) plays the same game within the bond universe, moving between bonds, convertibles and loans, investment grade and junk, domestic and foreign.  Since inception in 2002, OSTIX has trounced the broad bond indexes (8.5% annually for nine years versus 5% for their benchmark) with less risk.  The team that manages those funds is large, talented, stable . . . and managing the new fund as well.

Second, Osterweis’s expenses, direct and indirect, are more reasonable than most.  The current 1.5% ratio is at the lower end for an active allocation fund, strikingly so for a tiny one.  And the other two Osterweis funds each started around 1.5% and then steadily lowered their expense ratios, year after year, as assets grew.  In addition, both funds tend to have lower-than-normal portfolio turnover, which decreases the drag created by trading costs.

Bottom Line

Many investors would benefit from using a balanced or allocation fund as a significant part of their portfolio.  Well done, such funds decrease a portfolio’s volatility, instill discipline in the allocation of assets between classes, and reduce the chance of self-destructive bipolar investing on our parts.  Given reasonable expenses, outstanding management and a long, solid track record, Osterweis Strategic Investment warrants a place on any investor’s due-diligence short list.

Fund website

Osterweis Strategic Investment

Quarterly Report

Fact Sheet

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

 

By David Snowball

Objective and Strategy

The fund pursues long-term growth by investing in 30-50 undervalued global stocks.  The managers look for four characteristics in their investments:

1. A high quality business
2. A strong balance sheet
3. Shareholder-focused management and
4. The stock selling for less than it’s worth.

Generally it avoids small cap caps.  It can invest in emerging markets, but rarely does so though many of its multinational holdings derived significant earnings from emerging market operations.   The managers can hedge their currency exposure, though they did not do so until the nuclear disaster in, and fiscal stance of, Japan forced them to hedge yen exposure in 2011.

Adviser

Artisan Partners of Milwaukee, Wisconsin.   Artisan has five autonomous investment teams that oversee twelve distinct U.S., non-U.S. and global investment strategies. Artisan has been around since 1994.  As of 3/31/2012, Artisan Partners managed $66.5 billion of which $35.8 billion was in funds and $30.7 billion is in separate accounts.  That’s up from $10 billion in 2000. They advise the 12 Artisan funds, but only 6% of their assets come from retail investors

Managers

Daniel J. O’Keefe and David Samra, who have worked together since the late 1990s.  Mr. O’Keefe co-manages this fund, Artisan International Value (ARTKX) and Artisan’s global value separate account portfolios.  Before joining Artisan, he served as a research analyst for the Oakmark international funds and, earlier still, was a Morningstar analyst.  Mr. Samra has the same responsibilities as Mr. O’Keefe and also came from Oakmark.  Before Oakmark, he was a portfolio manager with Montgomery Asset Management, Global Equities Division (1993 – 1997).  Messrs O’Keefe, Samra and their five analysts are headquartered in San Francisco.  ARTKX earns Morningstar’s highest accolade: it’s a Five Star star with a “Gold” rating assigned by Morningstar’s analysts (as of 04/12).

Management’s Stake in the Fund

Each of the managers has over $1 million here and over $1 million in Artisan International Value.

Opening date

December 10, 2007.

Minimum investment

$1000 for regular accounts, reduced to $50 for accounts with automatic investing plans.  Artisan is one of the few firms who trust their investors enough to keep their investment minimums low and to waive them for folks willing to commit to the discipline of regular monthly or quarterly investments.

Expense ratio

1.5%, after waivers, on assets of $149 million (as of March 31, 2012).

Comments

Can you say “it’s about time”?

I have long been a fan of Artisan Global Value.  It was the first “new” fund to earn the “star in the shadows” designation.  Its management team won Morningstar’s International-Stock Manager of the Year honors in 2008 and was a finalist for the award in 2011. In announcing the 2011 nomination, Morningstar’s senior international fund analyst, William Samuel Rocco, observed:

Artisan Global Value has . . .  outpaced more than 95% of its rivals since opening in December 2007.  There’s a distinctive strategy behind these distinguished results. Samra and O’Keefe favor companies that are selling well below their estimates of intrinsic value, consider companies of all sizes, and let country and sector weightings fall where they may. They typically own just 40 to 50 names. Thus, both funds consistently stand out from their category peers and have what it takes to continue to outperform. And the fact that both managers have more than $1 million invested in each fund is another plus.

We attributed that success to a handful of factors:

First, the [managers] are as interested in the quality of the business as in the cost of the stock.  O’Keefe and Samra work to escape the typical value trap by looking at the future of the business – which also implies understanding the firm’s exposure to various currencies and national politics – and at the strength of its management team.

Second, the fund is sector agnostic. . .  ARTGX is staffed by “research generalists,” able to look at options across a range of sectors (often within a particular geographic region) and come up with the best ideas regardless of industry.  That independence is reflected in . . . the fund’s excellent performance during the 2008 debacle. During the third quarter of 2008, the fund’s peers dropped 18% and the international benchmark plummeted 20%.  Artisan, in contrast, lost 3.5% because the fund avoided highly-leveraged companies, almost all banks among them.

In designated ARTGX a “Star in the Shadows,” we concluded:

On whole, Artisan Global Value offers a management team that is as deep, disciplined and consistent as any around.  They bring an enormous amount of experience and an admirable track record stretching back to 1997.  Like all of the Artisan funds, it is risk-conscious and embedded in a shareholder-friendly culture.  There are few better offerings in the global fund realm.

In the past year, ARTGX has continued to shine.  In the twelve months since that review was posted, the fund finished in the top 6% of its global fund peer group.  Since inception (through April 2012), the fund has turned $10,000 into $11,700 while its average peer has lost $1200.  Much of that success is driven by its risk consciousness.  ARTGX has outperformed its peers in 75% of the months in which the global stock group lost money.  Morningstar reports that its “downside capture” is barely half as great as its peers.  Lipper designates it as a “Lipper Leader” in preserving its investors’ money.

Bottom Line

While money is beginning to flow into the fund (it has grown from $57 million in April 2011 to $150 million a year later), retail investors have lagged institutional ones in appreciating the strategy.  Mike Roos, one of Artisan’s managing directors, reports that “the Fund currently sits at roughly $150 million and the overall strategy is at $5.4 billion (reflecting meaningful institutional interest).”  With 90% of the portfolio invested in large and mega-cap firms, the managers could easily accommodate a far larger asset base than they now have.  We reiterate our conclusion from 2008 and 2011: “there are few better offerings in the global fund realm.”

Fund website

Artisan Global Value Fund

RMS (a/k/a FundReveal) provides a discussion of the fund’s risk/return profile, based on their messages of daily volatility, at http://www.fundreveal.com/mutual-fund-blog/2012/05/artgx-analysis-complementing-mutual-fund-observer-may-1-2012/

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

This profile has been updated. Find the new profile here. 

Objective and Strategy

Tributary Balanced Fund seeks capital appreciation and current income. They allocate assets among the three major asset groups: common stocks, bonds and cash equivalents. Based on their assessment of market conditions, they will invest 25% to 75% of the portfolio in stocks and convertible securities, and at least 25% in bonds. The portfolio is typically 70-75 stocks from small- to mega-cap and turnover is about half of the category average.  They currently hold about 50 bonds.

Adviser

Tributary Capital Management.  At base, Tributary is a subsidiary of First National Bank of Omaha and the Tributary funds were originally branded as the bank’s funds.  Tributary advises seven mutual funds, as well as serving high net worth individuals and institutions.  As December 31, 2011, they had about $1.1 billion under management.

Managers

Kurt Spieler and John Harris.  Mr. Spieler is the lead manager and the Managing Director of Investments for the advisor.  In that role, he develops and manages investment strategies for high net worth and institutional clients. He has 24 years of investment experience in fixed income, international and U.S. equities including a stint as Head of International Equities for Principal Global Investors and President of his own asset management firm.  Mr. Harris is a Senior Portfolio Manager for the advisor.  He joined Tributary in 2007 and this fund’s team in 2010.  He has 18 years of investment management experience including analytical roles for Principal Global Investors and American Equity Investment Life Insurance Company.

Management’s Stake in the Fund

Mr. Spieler has over $100,000 in the fund.  Mr. Harris has $10,000 in the fund, an amount limited by his “an interest in a more aggressive stock allocation.”

Opening date

August 6, 1996

Minimum investment

$1000, reduced to $100 for accounts opened with an automatic investing plan.

Expense ratio

1.22%, after a minor waiver, on $59 million in assets (as of 2/29/12).

Comments

Tributary Balanced does what you want to “balanced” fund to do.  It uses a mix of stocks and bonds to produce returns greater than those associated with bonds with volatility less than that associated with stocks.   Morningstar’s “investor returns” research supports the notion that this sort of risk consciousness is probably the most profitable path for the average investor to follow.

What’s remarkable is how very well, very quietly, and very consistently Tributary achieves those objectives.  The fund has returned 7.6% per year for the past decade, 50% better than its peer group, but has taken on no additional risk to achieve those returns.  Its Morningstar profile, as of 3/28/12, looks like this:

	Rating	Returns	Risk	Returns relative to peers
Past three years	* * * * *	High	Average	Top 1%
Past five years	* * * * *	High	Average	Top 1%
Past ten years	* * * * *	High	Average	Top 2%
Overall	* * * * *	High	Average	n/a

Its Lipper rankings, as of 3/28/12, parallel Morningstar’s:

	Total return	Consistency	Preservation
Past three years	* * * * *	* * * * *	* * * *
Past five years	* * * * *	* * * * *	* * * *
Past ten years	* * * * *	* * * * *	* * *
Overall	* * * * *	* * * * *	* * * *

We commissioned an analysis of the fund by the folks at Investment Risk Management Systems (a/k/a FundReveal), who looked at daily volatility and returns, and concluded “FOBAX is a well-managed, safe, low risk Moderate Allocation fund.

• Its low volatility, high return performance is visible in cumulative 5 year, latest cumulative one year and latest quarter analysis results.
• Its Persistence Rating (PR) is 60, indicating that it has maintained an “A-Best” rating over most of last 20 quarters.
• This is also evident from the rolling 20 quarters Risk-Return ratings which have been between “A-Best” and “C-Less Risky.”

Our bottom line opinion is that FOBAX seems to be one of the better managed funds in the Moderate Allocation class.”

SmartMoney provides a nice visual representation of the risk-return relationships of funds.  Below is the three-year scatterplot for the balanced fund universe.  In general, an investor wants to be as near the upper-left corner (universe returns, zero risk) as possible.  There are three things to notice in this graph:

1. Three funds form the group’s northwest boundary; that is, three that have a distinguished risk-return balance.  They are Tributary, Vanguard Balanced Index (VBINX) which is virtually unbeatable and Calvert Balanced (CSIFX) which provides middling returns with quite muted risk.
2. The only funds with higher returns (Fidelity Asset Manager 85% FAMRX and T. Rowe Price Personal Strategy Growth TRSGX than Tributary have far higher stock allocations (around 85%), far higher volatility and took 70% greater losses in 2008.
3. Ken Heebner is sad.  His CGM Mutual (LOMMX) is the lonely little dot in the lower right.

To what could we attribute Tributary’s success? Mr. Spieler claims three sources of alpha, or positive risk-adjusted returns.  They are:

1. They have a flexible asset allocation, which is driven by a macro-economic assessment, profit analysis and valuation analysis.  In theory the fund might hold anywhere between 25-75% in equities though the actual allocation tends to sit between 50-70%.
2. Stock selection tends to be opportunistic.  The portfolio tilts toward growth stocks and the managers are particularly interested in emerging markets growth stocks.  The neat trick is they pursue their interest without investing in foreign stocks by looking for US firms whose earnings benefit from emerging markets operations.  Pricesmart PSMT, for example, has 100% of its operations in South America while Cognizant Technology Solutions CTSH is a play on outsourcing to South Asia.  They’re also agnostic as to market cap.  Measured by the percentage of earnings from international sources, Tributary offers considerable international exposure.  They etimate that 48% of revenues of for their common stock holdings are from international sales. That compares to an estimated 42% of international sales for the S&P 500.
3. Fixed-income selection is sensitive to duration targets and unusual opportunities. About 20% of the portfolio is invested in taxable municipal bonds, such as the Build America Bonds.  Those were added to the portfolio when irrational fear gripped the fixed income market and investors were willing to sell such bonds as a substantial discount in order to flee to the safety of Treasuries.  Understanding that the fundamentals behind the bonds were solid, the managers snatched them up and booked a solid profit.

The managers are also risk-conscious, which is appropriate everywhere and especially so in a balanced fund.  The stock portfolio tends to be sector-neutral, and the number of names (typically 70-75) was based on an assessment of the amount of diversification needed for reasonable risk management.

Bottom Line

The empirical record is pretty clear.  Almost no fund offers a consistently better risk-return profile.  While it would be reassuring to see somewhat lower expenses or high insider ownership, Tributary has clearly earned a spot on the “due diligence” list for any investor interested in a hybrid fund.

Fund website

Tributary Funds.  FundReveal’s complete analysis of the fund is available on their blog.

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

This profile has been updated. Find the new profile here. 

Objective and Strategy

MASNX seeks to achieve long-term returns with lower risk and lower volatility than the stock market, and with relatively low correlation to stock and bond market indexes.  Relative to “moderate allocation” hybrid funds, the advisor’s goals are less volatility, better down market performance, fewer negative 12‐month losses, and higher returns over a market cycle. Their strategy is to divide the fund’s assets up between four teams, each pursuing distinct strategies with the whole being uncorrelated with the broad markets.  They can, in theory, maintain a correlation of .50 relative to the US stock market.

Adviser

Litman Gregory Fund Advisors, LLC, of Orinda, California. At base, Litman Gregory (1) conceives of the fund, (2) selects the outside management teams who will manage portions of the portfolio, and (3) determines how much of the portfolio each team gets.  Litman Gregory provides these services to five other funds (Equity, Focused Opportunities, International, Smaller Companies and Value). Collectively, the funds hold about $2.4 billion in assets.

Manager(s)

Jeremy DeGroot, Litman Gregory’s chief investment officer gets his name on the door as lead manager but the daily investments of the fund are determined bythree teams, and Jeff Gundlach. There’s a team from FPA led by Steve Romick, a team from Loomis Sayles led by Matt Eagan, a team from Water Island Capital led by John Orrico.  And Jeff Gundlach.

Management’s Stake in the Fund

None yet reported.

Opening date

September 30, 2011.

Minimum investment

$1000 for regular accounts, $500 for IRAs.  The fund’s available, NTF, through Fidelity, Scottrade and a few others.

Expense ratio

1.74%, after waivers, on $230 million in assets (as of 2/23/12).  There’s also a 2% redemption fee for shares held fewer than 180 days.  The expense ratio for the institutional share class is 1.49%.

Comments

Investors have, for years, been reluctant to trust the stock market.  Investors have pulled money for pure equity funds more often than they’ve invested in them.  An emerging conventional wisdom is that domestic bonds are at the end of a multi-decade bull market.  Investors have sought, and fund companies have provided, a welter of “alternative” funds.  Morningstar now tracks 262 funds in their various “alternative” categories.  Sadly, many such funds are bedeviled by a combination of untested management (the median manager tenure is just two years), opaque strategies and high expenses (the category average is 1.83% with a handful charging over 3% per year).

All of which makes MASNX look awfully attractive by comparison.

The Litman Gregory folks started with a common premise: “In the years ahead, we believe there will be mediocre returns and higher volatility from stocks, and low returns from bonds . . . [we sought] “alternative” strategies that we believe are not highly dependent on tailwinds from stocks and bonds to generate returns.”  Their search led them to hire four experienced fund management teams, each responsible for one sleeve of the fund’s portfolio.

Those teams are:

Matt Eagan and a team from Loomis-Sayles who are charged with implementing an Absolute-Return Fixed-Income which centers on high-yield and international bonds, with the prospect of up to 20% equities.  Their goal is “positive total returns over a full market cycle.”

John Orrico and a team from Water Island Capital, who are charged with an arbitrage strategy.  They manage the Arbitrage Fund (ARBFX) and target returns “of at least mid-single-digits with low correlation” to the stock and bond markets.  ARBFX averages 4-5% a year with low volatility; in 2008, for instance, is lost less than 1%.

Jeffrey Gundlach and the DoubleLine team, who will pursue an “opportunistic income” strategy.  The goal is “positive absolute returns” in excess of an appropriate broad bond index.  Gundlach uses this strategy in at least one hedge fund, a closed-end fund, DoubleLine Core Fixed Income (DLFNX) and Aston and RiverNorth funds for which he’s a subadvisor.

Steve Romick and a team from FPA, who will seek “contrarian opportunities” in pursuit of “equity-like returns over longer periods (i.e., five to seven years) while seeking to preserve capital.”   Romick manages FPA Crescent (FPACX) which wins almost universal acclaim (Five Star, Gold, LipperLeader) for its strong returns, risk consciousness and flexibility.

Litman Gregory picked these teams on two grounds: the fact that the strategies made sense taken as a portfolio and the fact that no one executed the strategies better than these folks.

The strategies are sensible, as a group, because they’re uncorrelated; that is, the factors which drive one strategy to rise or fall have little effect on the others.  As a result, a spike in inflation or a rise in interest rates might disadvantage one strategy while allow others to flourish. The inter-correlations between the four strategies are low (though “how low” will vary depending on market conditions).  Litman anticipates a correlation between the fund and the stock market in the range of 0.5, with a potentially-lower correlation to the bond markets.  That’s far lower than the two-year correlation between U.S. large cap stocks and, say, emerging markets stocks, REITs, international real estate or commodities.

The record of the sub-advisors speaks for itself: these really do represent the “A” team in the “alternatives without idiocy” space.  That is, these folks pursue sensible, comprehensible strategies that have worked over time.  Many of their competitors in the “multi-alternative” category pursue bizarre and opaque strategies (“hedge fund index replicant” strategies using derivatives) where the managers mostly say “trust us” and “pay us.”  On whole, this collection is far more reassuring.

Can Litman Gregory pull it off?  That is, can they convert a good idea and good managers into a good fund?  Likely.  First, the other Litman funds have been consistently solid if somewhat volatile performers.

	Current Morningstar	Morningstar Risk	Current Lipper Total Return	Current Lipper Preservation
Equity	* *	Above Average	* * *	* * *
Focused Opportunities	* * *	Above Average	* * * * *	* * * *
International	* * * *	Above Average	* * * *	* *
Smaller Companies	* * *	Above Average	* * * *	* *
Value	* *	Above Average	* * *	* * *

(all ratings as of 3/30/2012)

Second, Alternative Strategies is likely to fare better than its siblings because of the weakness of its peer group.  As I note above, most of the “multi-alternative” funds are profoundly unattractive and there are no low-cost, high-performance competitors in the space as there is in domestic equities.

Third, the fund’s early performance is promising.  We commissioned an analysis of the fund by the folks at Investment Risk Management Systems (a/k/a FundReveal), who looked at daily volatility and returns, and concluded:

Despite its short existence, the daily returns produced by the fund can indicate the effectiveness of fund investment decision-making . . . We have analyzed the fund performance for 126 market days, using the last 2 rolling quarters of 63 market days each. The daily FundReveal information makes it possible to get an idea of how well the fund is being managed. . . Based on the data available, MASNX is a safe fund which maintains very low risk (volatility). This is important in turbulent and uncertain markets. It is one of the top ranking funds in the safety category. Very few funds have higher ADR (average daily return) and lower Volatility than MASNX.

IRMS and I both add the obvious caveat: it’s still a very limited dataset, reflects the fund’s earliest stages and its performance under a limited set of market conditions.

The final question is, could you do better on your own?  That is, could you replicate the strategy by simply buying equal amounts of four mutual funds?  Not quite.  There are three factors to consider.  First, the portfolios wouldn’t be the same.  Litman has commissioned a sort of “best ideas” subset from each of the managers, which will necessarily distinguish these portfolios from their funds’.  Second, the dynamics between the sleeves of your portfolio – rebalancing and reweighting – wouldn’t be the same.  While each portfolio has a roughly-equal weight now, Litman can move money both to rebalance between strategies and to over- or under-weight particular strategies as conditions change.  Few investors have the discipline to do that sort of monitoring and moving.  Finally, the economics wouldn’t be the same.  It would require $10,000 to establish an equal-weight portfolio of funds (the Loomis minimum is $2500) and Loomis carries a front load that’s not easily dodged.  Assuming a three-year holding period and payment of a front load, the portfolio of funds would cost 1.52% while MASNX costs 1.74%.

Bottom Line

In a February Wall Street Journal piece, I nominated MASNX as one of the three most-promising new funds released in 2011.  In normal times, investors might be looking at a moderate stock/bond hybrid for the core of their portfolio.  In extraordinary times, there’s a strong argument for looking here as they consider the central building blocks for their strategy.

Fund website

Litman Gregory Masters Alternative Strategies.  The fund’s FAQ is particularly thorough and well-written; I’d recommend it to anyone investigating the possibility of investing in the fund.  IRMS provides the more-complete discussion of MASNX on their blog.

2013 Q3 Report

Fund Facts

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

Objective

The fund’s investment objective is capital appreciation, which they hope to obtain by investing primarily in undervalued small cap stocks.  Small caps are defined as those comparable to those in the Russell 2000, whose largest stocks are about $3.3 billion.  They can also invest up to 10% in foreign stocks, generally through ADRs.  There’s a comparable strategy – the “GRT Value Strategy – Long only U.S. Equity Strategy” – used when they’re investing in private accounts. They describe the objective there in somewhat more interesting terms.  In those accounts, they want to achieve “superior total returns while” – this is the part I like – “minimizing the probability of permanent impairment of capital.”

Adviser

GRT Capital Partners.  GRT was founded in 2001 by Gregory Fraser, Rudolph Kluiber and Timothy Krochuk.  GRT offers investment management services to institutional clients and investors in its limited partnerships.  As of 09/30/2011, they had about $315 million in assets under management.  They also advise the GRT Absolute Return (GRTHX) fund.

Managers

The aforementioned Gregory Fraser, Rudolph Kluiber and Timothy Krochuk.  Mr. Kluiber is the lead manager.  From 1995 to 2001, he ran State Street Research Aurora (SSRAX), a small cap value fund which is now called BlackRock Aurora.  Before that, he was a high yield analyst and assistant manager on State Street Research High Yield.  Mr. Fraser managed Fidelity Diversified International from 1991 to 2001.  Mr. Krochuk managed Fidelity TechnoQuant Growth Fund from 1996 to 2001 and Fidelity Small Cap Selector fund in 2000 and 2001.  The latter two “work closely with Mr. Kluiber and play an integral part in generating investment ideas and making recommendations for the Fund.” Since 2001, they’ve worked together on limited partnerships and separate accounts forGRT Capital. All three managers earned degrees from Harvard, where Mr. Kluiber and Mr. Fraser were roommates.

Management’s Stake in the Fund

As of 07/31/2011, Messrs Kluiber and Fraser each had $500,000 – $1,000,000 in the fund while Mr. Krochuk had more than $1 million.

Opening date

May 1, 2008.

Minimum investment

$2,500 for regular accounts, $500 for retirement accounts and $250 for spousal IRAs.

Expense ratio

1.30%, after waivers, on assets of $120 million, unchanged since the fund’s launch.  There’s also a 2% redemption fee for shares held fewer than 14 days.

Comments

Investors looking to strengthen the small cap exposure in their portfolios owe it to themselves to look at GRT Value.  It’s that simple.

On the theme of “keeping it simple,” I’ll add just two topics: what do they do? And why should you consider them?

What do they do?

GRT Value follows a long-established discipline.  It invests, primarily, in undervalued small company stocks.  Because of a quirk in data reporting, the portfolio might seem to have more growth stock exposure than it does.  The manager highlights three sorts of investments:

Turnaround Companies – those “that have declined in value for business or market reasons, but which may be able to make a turnaround because of, for instance, a renewed focus on operations and the sale of assets to help reduce debt.” Because indexes might be reconstituted only once or twice a year, some of the fund’s holdings remain characterized as “growth stocks” despite a precipitous decline in valuation.

Deep Value Companies – those which are cheap relatively to “the value of their assets, the book value of their stock and the earning potential of their business.”

Post-Bankruptcy Companies – which are often underfollowed and shunned, hence candidates for mispricing.

The fortunes of these three types of securities don’t move in sync, which tends to dampen volatility.

As with some of the Artisan teams, GRT uses an agricultural analogy for portfolio construction.  They have “a ‘farm team’ investment process [in which] positions often begin relatively small and increase in size as the Adviser’s confidence grows and the original investment thesis is confirmed.”  The manager’s cautious approach to new positions and broad diversification (188 names, as of 10/31/11), work to mitigate risk.

The managers are pretty humble about all of this: “There is no magic formula,” they write.  “It simply comes down to experienced managers, using well-established risk guidelines for portfolio construction” (Annual Report, 07/31/11).

Why should you consider them?

They’re winners.  The system works.  High returns, muted risk.

GRTValue seems to be an upgraded version of State Street Research Aurora, which Mr. Kluiber ran with phenomenal success for six years.  Morningstar’s valedictory assessment when he left the fund was this:

Kluiber, the fund’s manager since its 1995 inception, built it into a category standout during his tenure. In fact, the fund gained an average of 28.9% per year from March 1995 throughApril 30, 2001, while its average small-cap value peer gained 15.5%.

The same analyst noted that the fund’s risk scores were low and that “[m]anagement’s willingness to go farther afield in small-value territory has been a boon over the long haul. For instance, management doesn’t shy away from investing in traditionally more growth-oriented sectors, such as technology, if valuations and fundamentals” are compelling.  The article announcing his departure concluded, “Kluiber had built a topnotch record since Aurora’s 1995 inception. The fund’s trailing three- and five-year returns for the period endingApril 27, 2001, rank in the top 5% of the small-cap value category;Auroraalso boasted relatively low volatility and superior tax efficiency.”

Hmmm . . . high returns, low risk, high tax efficiency all maintained over time.  Those seek like awfully promising attributes in your lead manager.

Since 2004, the trio have been managing separate accounts using the strategies embodied in both Aurora andGRTValue.  They modestly trailed the Russell 2000 index in their first year of operation, then substantially clubbed it in the following three.  That reflects a focus on getting it right, every day. “We’re just grinders,” Mr. Krochuk noted.  “We come in every day and do our jobs together.”  In baseball terms, they were hoping to make contact and hit lots of singles rather than counting on swinging for the fences in pursuit of rare, spectacular gains.

Since 2008, GRT Value has continued the tradition of clubbing the competition.  At this point, the story gets muddied by Morningstar’s mistake.  Morningstar categorizes GRTVX as a mid-cap blend fund.  It’s not.  Never has been.  The portfolio is more than 80% small- and micro-cap.  The fund’s average market cap – $790 million – is less than half of the average small blend fund’s.  It’s below the Russell 2000 average.  That miscategorization throws off all of Morningstar’s peer assessments for star rating, relative returns, and relative risk.  Judged as a small-blend or small-value fund, they’re actually better than Morningstar’s five-star rating implies.

GRTVX has substantially outperformed its peers since inception: $10,000 invested at the fund’s opening has grown to $13,200, compared to $11,800 at its average peer

GRTVX has outperformed its benchmark in down markets: it has lost less, or actually registered gains, in 11 of the 14 months in which the index declined (from 01/09 – 02/12).  That’s consistent both with Mr. Kluiber’s risk-consciousness and his long-term record.

GRTVX has a consistently better risk-return profile than the best small blend funds. Morningstar analysts have identified five best-of-the-best funds in the small blend category.  Those are Artisan Small Cap Value (ARTVX, closed), Bogle Small Growth (BOGLX, the retail shares), Royce Special (RYSEX, closed), Vanguard Small Cap Index (NAESX, the retail shares) and Vanguard Tax-Managed Small-Cap Fund (VTMSX, the Admiral Shares).  Using Fund Reveal’s fine-grained risk and return data, GRTVX offers a better risk-return profile – over the trailing one, two and three year periods – than any of them.  The only fund (RYSEX) with somewhat-lower volatility has substantially lower returns.  And the only fund with better average daily returns (BOGLX) has substantially higher volatility.

Bottom Line

Nothing in life is certain, but the prospects forGRT Value’s future are about as close as you’ll get.  The managers have precisely the right experience.  They have outstanding, complementary track records.  They have an organizational structure in which they have a sense of control and commitment.  Its three year record, however measured, has been splendid.

Fund website

The fund’s website is virtually nonexistent. There’s a little more information available at the parent site, but not all that much.

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

Objective and Strategy

MAINX seeks total return over the long term with an emphasis on income. The fund invests in income-producing securities which will include government, quasi-governmental and corporate bonds, dividend-paying stocks and convertible securities (a sort of stock/bond hybrid).  The fund may hedge its currency exposure, but does not intend to do so routinely.  In general, at least half of the portfolio will be in investment-grade bonds.  Equities, both common stocks and convertibles, will not exceed 20% of the portfolio.

Adviser

Matthews International Capital Management. Matthews was founded in 1991.  As of December 31, 2011, Matthews had $15.3 billion in assets in its 13 funds.  On whole, the Matthews funds offer below average expenses. Over the past three years, every Matthews fund has above-average performance except for Asian Growth & Income (MACSX). They also publish an interesting and well-written newsletter on Asian investing, Asia Insight.

Manager(s)

Teresa Kong is the lead manager.  Before joining Matthews in 2010, she was Head of Emerging Market Investments at Barclays Global Investors (now BlackRock) and responsible for managing the firm’s investment strategies in Emerging Asia, Eastern Europe, Africa and Latin America. In addition to founding the Fixed Income Emerging Markets Group at BlackRock, she was also Senior Portfolio Manager and Credit Strategist on the Fixed Income credit team.  She’s also served as an analyst for Oppenheimer Funds and JP Morgan Securities, where she worked in the Structured Products Group and Latin America Capital Markets Group.  Kong has two co-managers, Gerald Hwang, who for the past three years managed foreign exchange and fixed income assets for some of Vanguard’s exchange-traded funds and mutual funds, and Robert Horrocks, Matthews’ chief investment officer.

Management’s Stake in the Fund

Every member of the team is invested in the fund, but the extent – typically substantial at Matthews – is not yet disclosed.

Opening date

November 30, 2011.

Minimum investment

$2500 for regular accounts, $500 for IRAs.  The fund’s available, NTF, through Fidelity, Vanguard, Scottrade and a few others.

Expense ratio

1.0%, after waivers, on $19 million in assets (as of 2/23/12).  That’s a 40 basis point decline from opening expense ratio. There’s also a 2% redemption fee for shares held fewer than 90 days.

Comments

With the Federal Reserve’s January 2012 announcement of their intent to keep interest rates near zero through 2014, conservative investors are being driven to look for new sources of income.  Ms. Kong highlights a risk the bond investors haven’t previously wrestled with: shortfall risk.  The combination of microscopic domestic interest rates with the slow depreciation of the U.S. dollar (she wouldn’t be surprised at a 2% annual loss against a basket of foreign currencies) and the corrosive effects of inflation, means that more and more “risk-free” fixed-income portfolios simply won’t meet their owners’ needs.  Surmounting that risk requires looking beyond the traditional.

For many investors, Asia is a logical destination.  Three factors support that conclusion:

1. Asian governments and corporations are well-positioned to service their debts.  On whole, debt levels are low and economic growth is substantial.  Haruhiko Kuroda of the Asian Development Bank projected (in late January 2012) that Asian economies — excluding Japan, Australia and New Zealand — to grow by around 7% in 2012, down from about 7.5% in 2011 and 9% in 2010.  France, by contrast, projects 0.5% growth, the Czech Republic foresees 0.2% and Germany, Europe’s soundest economy, expects 0.7%.
   This high rate of growth is persistent, and allows Asian economies to service their debt more and more easily each year.  Ms. Kong reports that Fitch (12/2011) and S&P (1/2012) both upgraded Indonesian debt, and she expects more upgrades than downgrades for Asia credits.
2. Most Asian debt supports infrastructure, rather than consumption.  While the Greeks were borrowing money to pay pensions, Asian governments were financing roads, bridges, transport, water and power.  Such projects often produce steady income streams that persist for decades, as well as supporting further growth.
3. Most investors are under-exposed to Asian debt markets.  Bond indexes, the basis for passive funds and the benchmark for active ones, tend to be debt-weighted; that is, the more heavily indebted a nation is, the greater weight it has in the index.  Asian governments and corporations have relatively low debt levels and have made relatively light use of the bond market.

Ms. Kong illustrated the potential magnitude of the underexposure.  An investor with a global diversified bond portfolio (70% Barclays US Aggregate bond index, 20% Barclays Global Aggregate, 10% emerging markets) would have only 7% exposure to Asia.  However you measure Asia’s economic significance (31% of global GDP, rising to 38% in the near future or, by IMF calculations, the source of 50% of global growth), even fairly sophisticated bond investors are likely underexposed.

The European debt crisis, morphing into a banking crisis, is making bank loans harder to obtain.  Asian borrowers are turning to capital markets to raise cash.  Asian blue chip firms issued $14 billion in bonds in the first two months of 2012, in a development The Wall Street Journal described as a “stampede” (02/23/12). The market for Asian debt is becoming larger, more liquid and more transparent.  Those are all good things for investors.

The question isn’t “should you have more exposure to Asian fixed-income markets,” but rather “should you seek exposure through Matthews?”  The answer, in all likelihood, is “yes.”   Matthews has the largest array of Asia investment products in the U.S. market, the deepest analytic core and the broadest array of experience.  They also have a long history of fixed-income investing in the service of funds such as Matthews Asian Growth & Income (MACSX).   Their culture and policies are shareholder-friendly and their success has been consistent.

Asia Strategic Income will be their first income-oriented fund.  Like FPA Crescent (FPACX) in the U.S. market, it has the freedom range across an entity’s capital structure, investing in equity, debt, hybrid or derivative securities depending on which offers the best returns for the risk.  The manager argues that the inclusion of modest exposure to equities will improve the fund’s performance in three ways.

1. They create a more favorable portfolio return distribution.  In essence, they add a bit more upside and the manager will try “to mitigate downside by favoring equities that have relatively low volatility, high asset coverage and an expected long term yield higher than the local 10 year Treasury.”
2. They allow the fund to exploit pricing anomalies.  There are times when one component of a firm’s capital structure might be mispriced by the market relative to another. .  Ms. Kong reports that the fund bought the convertible shares of an “Indian coal mining company.  Its parent, a London-listed natural resource company, has bonds outstanding at the senior level.  At the time of purchase, the convertibles of the subsidiary offered higher yield, higher upside than the parent’s bonds even though the Indian coal mining had better fundamentals, less leverage, and were structurally senior since the entity owns the assets directly.”
3. They widen the fund’s opportunity set.  Some governments make it incredibly difficult for foreigners to invest, or invest much, in their bonds.  Adding the ability to invest in equities may give the managers exposure to otherwise inaccessible markets.

Unlike the indexes, MAINX will weight securities by credit-worthiness rather than by debt load, which will further dampen portfolio risk.  Finally, the fund’s manager has an impressive resume, she comes across as smart and passionate, and she’s supported by a great organization.

Bottom Line

MAINX offers rare and sensible access to an important, under-followed asset class.  The long track record of Matthews’ funds suggests that this is going to be a solid, risk-conscious and rewarding vehicle for gaining access to that class.  Despite the queasiness that conservative investors, especially, might feel about investing what’s supposed to be their “safe” money overseas, there’s a strong argument for looking carefully at this as a supplement to an otherwise stagnant fixed-income portfolio.

Fund website

Matthews Asia Strategic Income

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By David Snowball

Objective and Strategy

The fund will pursue long-term capital growth by investing in a portfolio of global equities with a strong bias towards small- and micro-cap companies. Investments will include companies based in the U.S., developed foreign countries, and emerging/frontier markets. The portfolio has flexibility to adjust its investment mix by market cap, country, and sector in order to invest where the best global opportunities exist.  The managers expect to typically have 100-150 holdings, though they are well above that for the short-term.

Adviser

Grandeur Peak Global Advisors is a small- and micro-cap focused global equities investment firm, founded in mid-2011, and comprised of a very experienced and collaborative investment team that worked together for years managing some of the Wasatch funds.  Global Opportunities and International Opportunities are their only two investment vehicles.  The funds have over $85 million in assets after three months of operation.

Managers

Robert Gardiner and Blake Walker.   Robert Gardiner managed or co-managed Wasatch Microcap (WMICX), Small Cap Value (WMCVX) and Microcap Value (WAMVX, in which I own shares).  In 2007, he took a sort of sabbatical from active management but continued as Director of Research.  During that sabbatical, he reached a few conclusions: (1) he loved managing money and needed to get back on the front lines, (2) the best investors will be global investor, (3) global microcap investing is the world’s most interesting sector, (4) and he had an increasing desire to manage his own firm.  He returned to active management with the launch of Wasatch Global Opportunities (WAGOX), a global go anywhere fund, focused primarily on micro and small cap companies.  From inception in late 2008 to June 2011 (the point of his departure), WAGOX turned a $10,000 investment into $23,500 while an investment in its average peer would have led to a $17,000 portfolio.  Put another way, WAGOX earned $13,500 or 92% more than its average peer managed.

Blake Walker co-managed Wasatch International Opportunities (WAIOX) from 2005-2011.  The fund was distinguished by outsized returns (top 10% of its peer group over the past five years, top 1% over the past three), and outsized stakes in emerging markets (nearly 50% of assets) and micro- to small-cap stocks (66% of assets, roughly twice what peer funds have).  In March 2011, for the second year in a row, Lipper designated WAIOX as the top International Small/Mid-Cap Growth Fund based on consistent (risk-adjusted) return for the five years through 2010.

They both speak French.  Mais oui!

Management’s Stake in the Fund

As of 1/27/2012, Mr. Gardiner is the largest shareholder in both funds, Mr. Walker “has a nice position in both funds” (their phrase) and all nine members of the Grandeur Peak Team are fund shareholders.  Eric Huefner makes an argument that I find persuasive: “We are all highly vested in the success of the funds and the firm. Every person took a significant pay cut (or passed up a significantly higher paying opportunity) to be here.”

Opening date

October 17, 2011.

Minimum investment

$2000 for regular accounts, $1000 for IRAs.  The fund’s available for purchase through all of the big independent platforms: Schwab, Fidelity, TD Ameritrade, Vanguard, Scottrade and Pershing.

Expense ratio

1.75% on $65 million in assets (as of January 27, 2012).

Comments

This is a choice, not an echo.  Most “global” funds invest in huge, global corporations.  Of roughly 250 global stock funds, 80% have average market caps over $10 billion.  Only six qualify as small cap funds.   While that large cap emphasis dampens risk, it also tends to dampen rewards and produces rather less diversification value for a portfolio.

Grandeur Peak Global Opportunities goes where virtually no one else does: tiny companies across the globe.  While these are intrinsically risky investments, they also offer the potential for huge rewards.  The managers invest exclusively in what they deem to be high-quality companies, measured by factors such as the strength of the management team, the firm’s return on capital and debt burden, and the presence of a sustainable competitive advantage.  They look for a mix of three sorts of securities:

Best-In-Class Growth Companies: fast earnings growth, good management, strong financials.  The strategy is to “find them small & undiscovered; buy and hold” until the market catches on.  In the interim,  capture the compounded earnings growth.

Fallen Angels: good growth companies that hit “a bump in the road” and are priced as value stocks.  The strategy is to buy them low and hold through the recovery.

Stalwarts: basically, blue chip micro-cap stocks.  Decent but not great growth, great financials, and the prospect of dividends or stock buy-backs.  The strategy is to buy them at a fair price but be careful of overpaying since their growth may be decelerating.

The question is: can this team manage an acceptable risk / reward balance for their investors.  The answer is: yes, almost certainly.

The reason for my confidence is simple: they’ve done it before and they’ve done it splendidly.  As their manager bios note, Gardiner and Blake have a record of producing substantial rewards for mutual fund investors and the two Grandeur Peak funds follow the same discipline as their Wasatch predecessors.

The real question for investors interested in global micro/small-cap investing is “why here rather than Wasatch?”  I put that question to Eric Huefner, Grandeur Peak’s president, who himself was a Wasatch executive.  He made three points:

1. We have structured our team differently. All six members of our research team are global analysts. At Wasatch we had an International Team and a Domestic Team. The two teams talked with each other, but we didn’t have global analysts. We believe that to pick the best companies in the world you have to be looking at companies from every corner of the world. Each of our analysts (which includes the PMs) has primary responsibility for 1-2 sectors globally. This ensures that we are covering all sectors, and developing sector expertise, but with a global view. Yet, our team is small enough that all six members are actively involved in vetting every idea that goes into the portfolios.
2. We feel more nimble than we did at Wasatch. Today (01/29/12) we have $87 million under management, whereas Wasatch has billions in Global Small Caps (including both funds and other accounts). When you are trying to move in and out of micro cap stocks this nimbleness really pays off – small amounts that add up. We plan to keep our firm a small boutique so that we don’t lose our ability to buy the stocks we want to.
3. We have great respect for the team at Wasatch and believe they are well positioned to continue their success. Running our own firm has simply been a long-time dream of ours. I would be kidding you to say that 2011 wasn’t a distracting year for Robert and Blake as we got our new firm up and running. We feel like we’re off to a good start, and the organizational tasks are now behind us. Robert and Blake are very much re-focused on research as we begin 2012, and we have committed to minimizing their marketing efforts in order to keep our priority on research/performance. The good news is that since it’s our own firm everyone is highly energized and having a great time.

The final point in Grandeur Peak’s favor is obvious and unstated: they have the guys that actually produced the record Wasatch now holds.

Bottom Line

Both the team and the strategy are distinctive and proven.  Few people pursue this strategy, and none pursue it more effectively than Messrs. Gardiner and Blake.  Folks looking for a way to add considerable diversity to the typical large/domestic/balanced portfolio really owe it to themselves to spend some time here.

Website

Grandeur Peak Global Opportunities

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By Editor

Objective and Strategy

The Bretton Fund seeks to achieve long-term capital appreciation by investing in a small number of undervalued securities. The fund invests in common stocks of companies of all sizes. It normally holds a core position of between 15 to 20 securities whose underlying firms combine a defensible competitive advantage, relevant products, competent and shareholder-oriented management, growth, and a low level of debt.  The manager wants to invest “in ethical businesses” but does not use any ESG screens; mostly he avoids tobacco and gaming companies.

Adviser

Bretton Capital Management, LLC.  Bretton was founded in 2010 to advise this fund, which is its only client.

Manager

Stephen Dodson.  From 2002 to 2008, Mr. Dodson worked at Parnassus Investments in San Francisco, California, where he held various positions including president, chief operating officer, chief compliance officer and was a co-portfolio manager of a $25 million California tax-exempt bond fund. Prior to joining Parnassus Investments, Mr. Dodson was a venture capital associate with Advent International and an investment banking analyst at Morgan Stanley. Mr. Dodson attended the University of California, Berkeley, and earned a B.S. in Business Administration from the Haas School of Business.

Management’s Stake in the Fund

Mr. Dodson has over a million dollars invested in the fund.  As of April 5, 2011, Mr. Dodson and his family owned about 75% of the fund’s shares.

Opening date

September 30, 2010.

Minimum investment

$5000 for regular accounts, $1000 for IRAs or accounts established with an automatic investment plan.  The fund’s available for purchase through E*Trade and Pershing.

Expense ratio

1.5% on $3 million in assets.

Comments

Mr. Dodson is an experienced investment professional, pursuing a simple discipline.  He wants to buy deeply discounted stocks, but not a lot of them.  Where some funds tout a “best ideas” focus and then own dozens of the same large cap stocks, Bretton seems to mean it when he says “just my best.”

As of 9/30/11, the fund held just 15 stocks.  Of those, six were large caps, three mid-caps and six small- to micro-cap.  His micro-cap picks, where he often discerns the greatest degree of mispricing, are particularly striking.  Bretton is one of only a handful of funds that owns the smaller cap names and it generally commits ten or twenty times as much of the fund’s assets to them.

In addition to being agnostic about size, the fund is also unconstrained by style or sector.  Half of the fund’s holdings are characterized as “growth” stocks, half are not.   The fund offers no exposure at all in seven of Morningstar’s 11 industry sectors, but is over weighted by 4:1 in financials.

This is the essence of active management, and active management is about the only way to distinguish yourself from an overpriced index.  Bretton’s degree of concentration is not quite unprecedented, but it is remarkable.  Only six other funds invest with comparable confidence (that is, invests in such a compact portfolio), and five of them are unattractive options.

Biondo Focus (BFONX) holds 15 stocks and (as of January 2012) is using leverage to gain market exposure of 130%.  It sports a 3.1% e.r.  A $10,000 investment in the fund on the day it launched was worth $7800 at the end of 2011, while an investment in its average peer for the same period would have grown to $10,800.

Huntington Technical Opportunities (HTOAX) holds 12 stocks (briefly: it has a 440% portfolio turnover), 40% cash, and 10% S&P index fund.  The expense ratio is about 2%, which is coupled with a 4.75% load.  From inception, $10,000 became $7200 while its average peer would be at $9500.

Midas Magic (MISEX).  The former Midas Special Fund became Midas Magic on 4/29/2011.  Dear lord.  The ticker reads “My Sex” and the name cries out for Clara Peller to squawk “Where’s The Magic?”  The fund reports 0% turnover but found cause to charge 3.84% in expenses anyway.  Let’s see: since inception (1986), the fund has vastly underperformed the S&P500, its large cap peer group, short-term bond funds, gold, munis, currency . . . It has done better than the Chicago Cubs, but that’s about it.  It holds 12 stocks.

Monteagle Informed Investor Growth (MIIFX) holds 12 stocks (very briefly: it reports a 750% turnover ratio) and 20% cash.  The annual report’s lofty rhetoric (“The Fund’s goal is to invest in these common stocks with demonstrated informed investor interest and ownership, as well as, solid earnings fundamentals”) is undercut by an average holding period of six weeks.  The fund had one brilliant month, November 2008, when it soared 36% as the market lost 10%.  Since then, it’s been wildly inconsistent.

Rochdale Large Growth (RIMGX) holds 15 stocks and 40% cash.  From launch through the end of 2011, it turned $10,000 to $6300 while its large cap peer group went to $10,600.

The Cook & Bynum Fund (COBYX) is the most interesting of the lot.  It holds 10 stocks (two of which are Sears and Sears Canada) and 30% cash.  Since inception it has pretty much matched the returns of a large-value peer group, but has done so with far lower volatility.

And so fans of really focused investing have two plausible candidates, COBYX and BRTNX.  Of the two, Bretton has a far more impressive, though shorter, record.  From inception through the end of 2011, $10,000 invested in Bretton would have grown to $11,500.  Its peer group would have produced an average return of $10,900. For 2011 as a whole, BRTNX’s returns were in the top 2% of its peer group, by Morningstar’s calculus.   Lipper, which classifies it as “multi-cap value,” reports that it had the fourth best record of any comparable fund in 2011.  In particular, the fund outperformed its peers in every month when the market was declining.  That’s a particularly striking accomplishment given the fund’s concentration and micro-cap exposure.

Bottom Line

Bretton has the courage of its convictions.  Those convictions are grounded in an intelligent reading of the investment literature and backed by a huge financial commitment by the manager and his family.  It’s a fascinating vehicle and deserves careful attention.

Fund website

Bretton Fund

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By Editor

This profile has been updated since it was originally published. The updated profile can be found at http://www.mutualfundobserver.com/2012/09/northern-global-tactical-asset-allocation-fund-bbalx-september-2011-updated-september-2012/

Objective

The fund seeks a combination of growth and income. Northern’s Investment Policy Committee develops tactical asset allocation recommendations based on economic factors such as GDP and inflation; fixed-income market factors such as sovereign yields, credit spreads and currency trends; and stock market factors such as domestic and foreign earnings growth and valuations.  The managers execute that allocation by investing in other Northern funds and outside ETFs.  As of 6/30/2011, the fund holds 10 Northern funds and 3 ETFs.

Adviser

Northern Trust Investments.  Northern’s parent was founded in 1889 and provides investment management, asset and fund administration, fiduciary and banking solutions for corporations, institutions and affluent individuals worldwide.  As of June 30, 2011, Northern Trust Corporation had $97 billion in banking assets, $4.4 trillion in assets under custody and $680 billion in assets under management.  The Northern funds account for about $37 billion in assets.  When these folks say, “affluent individuals,” they really mean it.  Access to Northern Institutional Funds is limited to retirement plans with at least $30 million in assets, corporations and similar institutions, and “personal financial services clients having at least $500 million in total assets at Northern Trust.”  Yikes.  There are 51 Northern funds, seven sub-advised by multiple institutional managers.

Managers

Peter Flood and Daniel Phillips.  Mr. Flood has been managing the fund since April, 2008.  He is the head of Northern’s Fixed Income Risk Management and Fixed Income Strategy teams and has been with Northern since 1979.  Mr. Phillips joined Northern in 2005 and became co-manager in April, 2011.  He’s one of Northern’s lead asset-allocation specialists.

Management’s Stake in the Fund

None, zero, zip.   The research is pretty clear, that substantial manager ownership of a fund is associated with more prudent risk taking and modestly higher returns.  I checked 15 Northern managers listed in the 2010 Statement of Additional Information.  Not a single manager had a single dollar invested.  For both practical and symbolic reasons, that strikes me as regrettable.

Opening date

Northern Institutional Balanced, this fund’s initial incarnation, launched on July 1, 1993.  On April 1, 2008, this became an institutional fund of funds with a new name, manager and mission and offered four share classes.  On August 1, 2011, all four share classes were combined into a single no-load retail fund but is otherwise identical to its institutional predecessor.

Minimum investment

$2500, reduced to $500 for IRAs and $250 for accounts with an automatic investing plan.

Expense ratio

0.68%, after waivers, on assets of $18 million. While there’s no guarantee that the waiver will be renewed next year, Peter Jacob, a vice president for Northern Trust Global Investments, says that the board has never failed to renew a requested waiver. Since the new fund inherited the original fund’s shareholders, Northern and the board concluded that they could not in good conscience impose a fee increase on those folks. That decision that benefits all investors in the fund. Update – 0.68%, after waivers, on assets of nearly $28 million (as of 12/31/2012.)

Comments

The case for this fund can be summarized easily.  It was a perfectly respectable institutional balanced fund which has become dramatically better as a result of two sets of recent changes.

Northern Institutional Balanced invested conservatively and conventionally.  It held about two-thirds in stocks (mostly mid- to large-sized US companies plus a few large foreign firms) and one-third in bonds (mostly investment grade domestic bonds).   Northern’s ethos is very risk sensitive which makes a world of sense given their traditional client base: the exceedingly affluent.  Those folks didn’t need Northern to make a ton of money for them (they already had that), they needed Northern to steward it carefully and not take silly risks.  Even today, Northern trumpets “active risk management and well-defined buy-sell criteria” and celebrates their ability to provide clients with “peace of mind.”  Northern continues to highlight “A conservative investment approach . . . strength and stability . . .  disciplined, risk-managed investment . . . “

As a reflection of that, Balanced tended to capture only 65-85% of its benchmark’s gains in years when the market was rising but much less of the loss when the market was falling.  In the long-term, the fund returned about 85% of its 65% stock – 35% bond benchmark’s gains but did so with low volatility.

That was perfectly respectable.

Since then, two sets of changes have made it dramatically better.  In April 2008, the fund morphed from conservative balanced to a global tactical fund of funds.  At a swoop, the fund underwent a series of useful changes.

The asset allocation became fluid, with an investment committee able to substantially shift asset class exposure as opportunities changed.

The basic asset allocation became more aggressive, with the addition of a high-yield bond fund and emerging markets equities.

The fund added exposure to alternative investments, including gold, commodities, global real estate and currencies.

Those changes resulted in a markedly stronger performer.  In the three years since the change, the fund has handily outperformed both its Morningstar benchmark and its peer group.  Its returns place it in the top 7% of balanced funds in the past three years (through 8/25/11).  Morningstar has awarded it five stars for the past three years, even as the fund maintained its “low risk” rating.  Over the same period, it’s been designated a Lipper Leader (5 out of 5 score) for Total Returns and Expenses, and 4 out of 5 for Consistency and Capital Preservation.

In the same period (04/01/2008 – 08/26/2011), it has outperformed its peer group and a host of first-rate balanced funds including Vanguard STAR (VGSTX), Vanguard Balanced Index (VBINX), Fidelity Global Balanced (FGBLX), Leuthold Core (LCORX), T. Rowe Price Balanced (RPBAX) and Dodge & Cox Balanced (DODBX).

In August 2011, the fund morphed again from an institutional fund to a retail one.   The investment minimum dropped from $5,000,000 to as low as $250.  The expense ratio, however, remained extremely low, thanks to an ongoing expense waiver from Northern.  The average for other retail funds advertising themselves as “tactical asset” or “tactical allocation” funds is about 1.80%.

Bottom Line

Northern GTA offers an intriguing opportunity for conservative investors.  This remains a cautious fund, but one which offers exposure to a diverse array of asset classes and a price unavailable in other retail offerings.  It has used its newfound flexibility and low expenses to outperform some very distinguished competition.  Folks looking for an interesting and affordable core fund owe it to themselves to add this one to their short-list.

Fund website

Northern Global Tactical Asset Allocation

Update – 3Q2011 Fact Sheet

Fund Profile, 2nd quarter, 2012

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

By Editor

This profile has been updated since it was originally published. The updated profile can be found at http://www.mutualfundobserver.com/2012/09/riverpark-short-term-high-yield-fund-rphyx-july-2011-updated-october-2012/

Objective

The fund seeks high current income and capital appreciation consistent with the preservation of capital, and is looking for yields that are better than those available via traditional money market and short term bond funds.  They invest primarily in high yield bonds with an effective maturity of less than three years but can also have money in short term debt, preferred stock, convertible bonds, and fixed- or floating-rate bank loans.

Adviser

RiverPark Advisers.  Executives from Baron Asset Management, including president Morty Schaja, formed RiverPark in July 2009.  RiverPark oversees the five RiverPark funds, though other firms manage three of the five.  Until recently, they also advised two actively-managed ETFs under the Grail RP banner.  A legally separate entity, RiverPark Capital Management, runs separate accounts and partnerships.  Collectively, they have $90 million in assets under management, as of May 2011.

Manager

David Sherman, founder and owner of Cohanzick Management of Pleasantville (think Reader’s Digest), NY.  Cohanzick manages separate accounts and partnerships.  The firm has more than $320 million in assets under management.  Since 1997, Cohanzick has managed accounts for a variety of clients using substantially the same process that they’ll use with this fund. He currently invests about $100 million in this style, between the fund and his separate accounts.  Before founding Cohanzick, Mr. Sherman worked for Leucadia National Corporation and its subsidiaries.  From 1992 – 1996, he oversaw Leucadia’s insurance companies’ investment portfolios.  All told, he has over 23 years of experience investing in high yield and distressed securities.  He’s assisted by three other investment professionals.

Management’s Stake in the Fund

30% of the fund’s investments come from RiverPark or Cohanzick.  However, if you include friends and family in the equation, the percentage climbs to about 50%.

Opening date

September 30, 2010.

Minimum investment

$1,000.

Expense ratio

1.25% after waivers on $20.5 million in assets.  The prospectus reports that the actual cost of operation is 2.65% with RiverPark underwriting everything above 1.25%.  Mr. Schaja, RiverPark’s president, says that the fund is very near the break-even point. Update – 1.25%, after waivers, on $53.7 million in assets (as of 12/31/2011.)

Comments

The good folks at Cohanzick are looking to construct a profitable alternative to traditional money management funds.  The case for seeking an alternative is compelling.  Money market funds have negative real returns, and will continue to have them for years ahead.  As of June 28 2011, Vanguard Prime Money Market Fund (VMMXX) has an annualized yield of 0.04%.  Fidelity Money Market Fund (SPRXX) yields 0.01%.  TIAA-CREF Money Market (TIRXX) yields 0.00%.  If you had put $1 million in Vanguard a year ago, you’d have made $400 before taxes.  You might be tempted to say “that’s better than nothing,” but it isn’t.  The most recent estimate of year over year inflation (released by the Bureau of Labor Statistics, June 15 2011) is 3.6%, which means that your ultra-safe million dollar account lost $35,600 in purchasing power.  The “rush to safety” has kept the yield on short term T-bills at (or, egads, below) zero.  Unless the U.S. economy strengths enough to embolden the Fed to raise interest rates (likely by a quarter point at a time), those negative returns may last through the next presidential election.

That’s compounded by rising, largely undisclosed risks that those money market funds are taking.  The problem for money market managers is that their expense ratios often exceed the available yield from their portfolios; that is, they’re charging more in fees than they can make for investors – at least when they rely on safe, predictable, boring investments.  In consequence, money market managers are reaching (some say “groping”) for yield by buying unconventional debt.  In 2007 they were buying weird asset-backed derivatives, which turned poisonous very quickly.  In 2011 they’re buying the debt of European banks, banks which are often exposed to the risk of sovereign defaults from nations such as Portugal, Greece, Ireland and Spain.  On whole, European banks outside of those four countries have over $2 trillion of exposure to their debt. James Grant observed in the June 3 2011 edition of Grant’s Interest Rate Observer, that the nation’s five largest money market funds (three Fidelity funds, Vanguard and BlackRock) hold an average of 41% of their assets in European debt securities.

Enter Cohanzick and the RiverPark Short Term High Yield fund.  Cohanzick generally does not buy conventional short term, high yield bonds.  They do something far more interesting.  They buy several different types of orphaned securities; exceedingly short-term (think 30-90 day maturity) securities for which there are few other buyers.

One type of investment is redeemed debt, or called bonds.  A firm or government might have issued a high yielding ten-year bond.  Now, after seven years, they’d like to buy those bonds back in order to escape the high interest payments they’ve had to make.  That’s “calling” the bond, but the issuer must wait 30 days between announcing the call and actually buying back the bonds.  Let’s say you’re a mutual fund manager holding a million dollars worth of a called bond that’s been yielding 5%.  You’ve got a decision to make: hold on to the bond for the next 30 days – during which time it will earn you a whoppin’ $4166 – or try to sell the bond fast so you have the $1 million to redeploy.  The $4166 feels like chump change, so you’d like to sell but to whom?

In general, bond fund managers won’t buy such short-lived remnants and money market managers can’t buy them: these are still nominally “junk” and forbidden to them.  According to RiverPark’s president, Morty Schaja, these are “orphaned credit opportunities with no logical or active buyers.”  The buyers are a handful of hedge funds and this fund.  If Cohanzick’s research convinces them that the entity making the call will be able to survive for another 30 days, they can afford to negotiate purchase of the bond, hold it for a month, redeem it, and buy another.  The effect is that the fund has junk bond like yields (better than 4% currently) with negligible share price volatility.

Redeemed debt (which represents 33% of the June 2011 portfolio) is one of five sorts of investments typical of the fund.  The others include

• Corporate event driven (18% of the portfolio) purchases, the vast majority of which mature in under 60 days. This might be where an already-public corporate event will trigger an imminent call, but hasn’t yet.  If, for example, one company is purchased by another, the acquired company’s bonds will all be called at the moment of the merger.
• Strategic recapitalization (10% of the portfolio), which describes a situation in which there’s the announced intention to call, but the firm has not yet undertaken the legal formalities.  By way of example, Virgin Media has repeatedly announced its intention to call certain bonds in August 2011. The public announcements gave the manager enough comfort to purchase the bonds, which were subsequently called less than 2 weeks later.  Buying before call means that the fund has to post the original maturities (five years) despite knowing the bond will cash out in (say) 90 days.  This means that the portfolio will show some intermediate duration bonds.
• Cushion bonds (14%), refers to a bond whose yield to maturity is greater than its current yield to call.  So as more time goes by (and the bond isn’t called), the yield grows. Because I have enormous trouble in understanding exactly what that means, Michael Dekler of Cohanzick offered this example:

A good example is the recent purchase of the Qwest (Centurylink) 7.5% bonds due 2014.  If the bonds had been called on the day we bought them (which would have resulted in them being redeemed 30 days from that day), our yield would only have been just over 1%.  But since no immediate refinancing event seemed to be in the works, we suspected the bonds would remain outstanding for longer.  If the bonds were called today (6/30) for a 7/30 redemption date, our yield on the original purchase would be 5.25%.  And because we are very comfortable with the near-term credit quality, we’re happy to hold them until the future redemption or maturity.

• Short term maturities (25%), fixed and floating rate debt that the manager believes are “money good.”

What are the arguments in favor of RPHYX?

• It’s currently yielding 100-400 times more than a money market.  While the disparity won’t always be that great, the manager believes that these sorts of assets might typically generate returns of 3.5 – 4.5% per year, which is exceedingly good.
• It features low share price volatility.  The NAV is $10.01 (as of 6/29/11).  It’s never been higher than $10.03 or lower than $9.97.  Almost all of the share price fluctuation is due to their monthly dividend distributions.    A $0.04 cent distribution at the end of June will cause the NAV will go back down to about $9.97. Their five separately managed accounts have almost never shown a monthly decline in value.  The key risk in high-yield investing is the ability of the issuer to make payments for, say, the next decade.  Do you really want to bet on Eastman Kodak’s ability to survive to 2021?  With these securities, Mr. Sherman just needs to be sure that they’ll survive to next month.  If he’s not sure, he doesn’t bite.  And the odds are in his favor.  In the case of redeemed debt, for instance, there’s been only one bankruptcy among such firms since 1985.
• It offers protection against rising interest rates.  Because most of the fund’s securities mature within 30-60 days, a rise in the Fed funds rate will have a negligible effect on the value of the portfolio.
• It offers experienced, shareholder-friendly management.  The Cohanzick folks are deeply invested in the fund.  They run $100 million in this style currently and estimate that they could run up to $1 billion. Because they’re one of the few large purchasers, they’re “a logical first call for sellers.  We … know how to negotiate purchase terms.”  They’ve committed to closing both their separate accounts and the fund to new investors before they reach their capacity limit.

Bottom Line

This strikes me as a fascinating fund.  It is, in the mutual fund world, utterly unique.  It has competitive advantages (including “first mover” status) that later entrants won’t easily match.  And it makes sense.  That’s a rare and wonderful combination.  Conservative investors – folks saving up for a house or girding for upcoming tuition payments – need to put this on their short list of best cash management options.

Financial disclosure: I intend to shift $1000 from the TIAA-CREF money market to RPHYX about one week after this profile is posted (July 1 2011) and establish an automatic investment in the fund.  That commitment, made after I read an awful lot and interviewed the manager, might well color my assessment.  Caveat emptor.

Note to financial advisers: Messrs Sherman and Schaja seem committed to being singularly accessible and transparent.  They update the portfolio monthly, are willing to speak individually with major investors and plan – assuming the number of investors grows substantially – to offer monthly conference calls to allow folks to hear from, and interact with, management.

Fund website

RiverPark Short Term High Yield

Update: 3Q2011 Fact Sheet

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact [email protected].